Leverage: The difference between linear and exponential growth

Leverage: The difference between linear and exponential growth

The word leverage evokes the imagery Bankers Gone Wild. There are the Barbarians who stormed the gates of RJR Nabisco during the 1980s leveraged buy out. There are the Failed Geniuses from Long-term Capital who leveraged Russian Bonds that ended up defaulting in 1998. And there’s the leveraged homeowner, coerced by their mortgage bankers into the chicanery of zero-down loans, HELOCs and reverse mortgages during the 2008 crisis. Is leverage an evil force that must be avoided at all costs?

One-third of the US population might disagree.

It turns out that leverage (in the form of equity in their home) drives a significant portion of US household wealth. (Interestingly, retirement accounts are a close second – a byproduct of forced savings?)

The “math” is actually quite simple. When you apply leverage to an asset that (tends to) go up over time, meaningful wealth creation ensues. Which brings bad and good news.

The bad news is that soaring real estate prices in many parts of the US (and the world) put home ownership out of reach for many. The good news is that financial leverage is one of many kinds of leverage in the knowledge worker toolkit.

The $10k framework explores non-financial ways to amplify your activities so that they become force multipliers.

For the uninitiated, there’s a natural temptation to play in the land of $1,000 work. That’s the land of domain expertise: the bankruptcy lawyer, financial advisor, or gifted software engineer. The pull towards this quadrant is quite compelling: your unique skills enable you to extract significant income.

But the exponential growth happens you combine those unique skill with leverage. It’s the magic key that lets you step off the treadmill of exchanging time for money.

But what is leverage?

“The business keeps moving, when you stop working,” is my pithy definition of leverage. Leverage is the often overlooked distinction between “working on your business and working in your business” (a phrase pioneered by Michael Gerber’s business classic The E-myth Revisited).

In Naval Ravikant’s epic tweetstorm How to Get Rich (without getting lucky), the Internet’s Philosopher explores other forms of leverage and concludes with the following rallying cry:

Leverage is a force multiplier for your judgement. Judgement requires experience, but can be built faster by learning foundational skills.

Ravikant goes on to create three distinct buckets of leverage: financial, labor, and a buzzier third category.

Financial Leverage

When I worked in the hedge fund industry, I was always baffled by the creative ways rich people used leverage to amplify their wealth. This included one billionaire who borrowed against his art collection to buy a ski house (true story). It’s why Elon Musk borrows money to pay rent. And more recently, it’s Bitcoin millionaires avoiding capital gains taxes by using crypto loans (i.e. using their bitcoin as collateral) to fund their most lavish Lambo Life.

As explored earlier, vast swaths of the population have access to financial leverage through the venerable 30 year mortgage. A trusted engine for meaningful wealth creation

In his tweetstorm (also summarized in the navalmanack), Ravikant adds:

Money is good as a form of leverage. It means every time you make a decision, you multiply it with money. Capital is a trickier form of leverage to use. It’s more modern. It’s the one that people have used to get fabulously wealthy in the last century. It’s probably been the dominant form of leverage in the last century.

Labor leverage

“The oldest form of leverage,” continues Ravikant, is “other humans working for you.” After all, would you rather be the lawyer who bills at $1,000 an hour – or the owner of the law firm that takes their cut? Yet Raivkant finds this form of leverage a bit long in the tooth:

I would argue this is the worst form of leverage that you could possibly use. Managing other people is incredibly messy. It requires tremendous leadership skills. You’re one short hop from a mutiny or getting eaten or torn apart by the mob.

While I’m all for automation via no-code tools and outsourcing low-level work to a VA, I’ll respectfully disagree with Ravikant. Yes, “managing other people is incredibly messy” – but as social animals, it’s one of the greatest gifts of the modern corporation. Furthermore, as a business owner being a good leader and manager is a critical component of $10k work and a tremendous opportunity for those willing to embrace it.

In the management classic High-Output Management, Andy Grove the late CEO of Intel distilled this leverage into a simple formula:

A manager’s output = The output of his organization + The output of the neighboring organizations under his influence

By amplifying and influencing the work of their direct reports, good managers created heaps of leverage. Furthermore, according to Grove, leverage spreads and compounds – even benefiting adjacent groups within an organization.

The entire book is a must-read for any manager, and Grove calls out a few pragmatic ways managers could replicate this leverage:

  • 1:1s
  • Meetings with clear outcomes and decisions
  • Coaching/training
  • Projects that align with organizational objectives

“Replication” leverage

Imagine you were a geeky computer scientist with a passion for cryptography and monetary theory. In your smokey basement, you come up with a some code and a white paper – and share the results with the Internet – without sacrificing your identity. Your idea (like any idea on the Internet) travels freely, enabling individuals buy into your vision by contributing their code and computing power.

Fast forward a decade, and this anonymous coder is worth $10 billion. That’s the Cliff Notes version of Satoshi Nakamoto and Bitcoin’s origin story.

Bitcoin is an example of Ravikant’s third form of leverage: products that have no marginal cost of replication. Bitcoin didn’t require employees, an office, or even any starting capital. And its spread as an idea reinforced its own value as a “currency.” Here’s Ravikant describing this third form of leverage:

This [form of leverage] was only invented in the last few hundred years. It started with the printing press. It accelerated with broadcast media, and now it’s really blown up with the internet and with coding. Now, you can multiply your efforts without involving other humans and without needing money from other humans.

Bitcoin (which is my example, not Ravikant’s) probably makes it seem more complicated than it actually is:

The new generation’s fortunes are all made through code or media. Joe Rogan making $50 million to $100 million a year from his podcast. You’re going to have PewDiePie. And of course, there’s Jeff Bezos, Mark Zuckerberg, Larry Page, Sergey Brin, Bill Gates, and Steve Jobs. Their wealth is all code-based leverage.

As someone who lives this this third form of leverage, I see its power and potential. But it’s really hard to do it alone – the FANG companies alone hire 287,000 employees – which means that there’s always going to be a large component of labor leverage.

The force multiplier

Can leverage be learned? What did Ravikant mean when he described leverage as the “force multiplier that can be built faster by learning foundational skills?” He goes on to elaborate:

There is no skill called “business.” Avoid business magazines and business classes. Study microeconomics, game theory, psychology, persuasion, ethics, mathematics, and computers.

During the RadReads $10k Bootcamp, we explored some of these timeless tactics.

Finding your sweet spot of your $10k work requires the disciplined pursuit of creativity, persistence, experimentation – and a little bit of luck. It’s a personal journey, without a predetermined playbook… but done right, the payoffs are spectacular.

Khe Hy
[email protected]

Khe Hy is the creator of RadReads.