Leverage Risk
The amplification of potential losses — and gains — that results from borrowing capital to invest.
What is Leverage Risk?
Leverage risk is the additional risk introduced when an investor or company uses borrowed capital (debt) to increase the size of an investment position beyond what their own equity would allow. Leverage amplifies returns in both directions: a 10% gain on a 2× leveraged position yields a 20% gain, but a 10% loss yields a 20% loss. The risk of leverage is asymmetric in its consequences: gains are capped by the asset's performance, but losses can exceed the initial equity investment and trigger margin calls, forced liquidations, or bankruptcy. In portfolios, leverage risk manifests through borrowed money (margin accounts), leveraged ETFs (which use derivatives to deliver daily multiples of benchmark returns), and hedge fund strategies. In corporate finance, high financial leverage increases a company's earnings volatility and risk of insolvency during downturns. Leverage is one reason why the 2008 financial crisis was so severe — financial institutions were highly leveraged and small declines in asset values wiped out equity cushions.
Example
An investor uses a 50% margin loan to buy $200,000 of stocks with $100,000 of equity. If the portfolio drops 30% (to $140,000), after repaying the $100,000 loan, only $40,000 of equity remains — a 60% loss on the original $100,000. A further 30% drop would wipe out the equity entirely and trigger a margin call to repay the broker.
Source: Investopedia — Leverage Risk