The concept of leverage has been in the news as of late (in a few different capacities) and a client asked what exactly it means. Let’s take a look at what it is, why extreme caution is advised, and why its proliferation is a risk to markets.

Leverage has multiple definitions but in the financial world, it refers to the use of borrowed capital. As it specifically relates to investors, the use of leverage involves borrowing money (typically using your existing portfolio as collateral), with the expectation that you can earn more on the investment of the borrowed funds than you’ll pay in interest to access them.

Here’s a very simple example. You have a brokerage account worth $1 million. Most custodians will issue margin loans up to 50% of the account value. You decide you want access to more funds for investment, so you take out the max margin loan, bringing your investable balance to $1.5 million (1 million plus the 50% loan). There is a cost to borrow this money (a relatively high interest rate, as of today, rate would be ~11% on this balance). To come out “ahead,” you’d need to earn over that amount on the investment of the $500,000.

This is all well and good and is a matter of waiting for the return to exceed interest – until when/if the balance of your account declines. Why is that an issue? Remember the loan is a capped percentage of your balance. If the market corrects and your original account balance falls to $900,000, your max margin loan is now $450,000 (50% of new balance). The custodian will collect the $50,000 immediately – requiring you to sell something to free up that cash. And if you don’t do it, they will do it for you! This dynamic (called margin calls or leverage unwind) can lead to exacerbated downside pressure in a market downturn as the leverage in the system (from large quant funds and hedge funds) is stunningly high in today’s market (margin debt was reported at $1.3 trillion in September 2025). We saw this just a few weeks ago when fears spiked of US/China trade war. Equity markets and most crypto currencies (all subject to large amounts of leverage) sold off sharply in part due to margin unwind.

Leverage is also increasingly used by investment products. I wrote about Leveraged ETFs in the summer . Since that time, the use of these products has only increased as has the leverage within them. As of October 2025, the number of leveraged equity ETFs hit a record 701 and several contain incredible leverage ratios (some as high as 5x)! When leverage becomes a product – and not a carefully managed and executed tool – it is a very worrisome sign. Increasingly, these products attract retail investors that may not fully understand their mechanics and are drawn only to their returns (which will be attractive in a rising market). The damage if/when a downturn occurs could be very harmful to many who are not prepared.

I noted at the beginning that the use of leverage in investing – as well as the ownership of leveraged ETFs – should be evaluated with extreme caution. The rising use of leverage is one of the biggest concerns I have with today’s markets. Leverage is a two-edge sword and can work against investors very rapidly (many of whom don’t fully appreciate just how much the downside will be magnified). An investor without leverage can ride out any market volatility (as you don’t have to sell). An investor with leverage won’t have a choice.

In my view, leverage is not suitable for the vast majority of investors and should be reserved for very specialized and rare situations. I don’t use it personally and I don’t use it in client accounts. There’s simply no rationale need. Sure, magnification of upside returns could be nice for a short period of time, but it is not worth the extreme risk of what will happen when the tide changes (and the tide always changes).