How Leverage Works

When an investor or a fund borrows money to invest in a given asset and invests that money along with its own money, returns are magnified. For example, if the fund invested $1 million in XYZ stock and borrowed $1 million to invest in XYZ, and XYZ rose by 10 percent, then the investor would actually realize a 20 percent return, disregarding the costs of carrying the loan. But leverage works both ways: If XYZ lost 10 percent, the fund would lose 20 percent, since the loan must still be repaid in full. If XYZ loses 50 percent, the fund's investment in the company would be wiped out.