The kicker on a couple of these is that the borrower pays no interest.
Before we go into alternate ways to use other people's money, let's first look at a traditional use of debt as a way to increase investment returns.
Let's use a real estate deal to show the power of using other people's money. Whose money does a real estate buyer use? The money usually comes from a bank.
Suppose you buy a house for $50,000 and one year later you sell the house for $55,000. If you paid cash, your $5,000 gain would equate to a 10 percent return on investment.
Suppose, though, you had put down $10,000 and borrowed the remaining $40,000. (In this case, you would have used $10,000 of your own money and $40,000 of other people's money.) In figuring your return on investment in this example, you would divide the same $5,000 gain by the $10,000 you invested.
Your return with debt is 50 percent, minus whatever interest the bank charges you for the loan. This is a vivid demonstration of the use of other people's money to dramatically increase returns.
The above example of using debt is the most common use of other people's money. However, read on to find some more powerful, if less understood, ways of using other people's money.
It may surprise you, but major retailers are masters at using other people's money. Whose money does a retailer use? That of its vendors. Let's see how.
Suppose that a store's inventory turns over 12 times a year. That means that it takes the retailer 30 days on average to sell each item it places on the shelf. Because retail customers have to pay for items immediately, that means that -- in theory -- they get paid in 30 days for the items they sell. Suppose they have negotiated terms with their vendors to pay for items in 60 days. This means that every single item on the store shelves is financed by other people's money -- the vendors.
The insurance industry is another business where tremendous returns are generated using other people's money. In the insurance industry, other people's money comes from those who pay premiums. As we all know, we pay an insurance company a certain amount of money in exchange for its paying us back if the insured event takes place. What is lost on many people is that not every claim occurs in the year the premium is paid.
Suppose the insured event doesn't happen until three years after the premium was paid. In this case, the insurer gets to use your money for three years interest-free. Of course, insurance companies invest the money they earn from premiums until they have to pay it back in the form of claims. In short, this means they get to earn investment income using other people's money -- their insured customers.
Bear in mind that two of the wealthiest people in recent U.S. history -- Sam Walton and Warren Buffett -- each used one of these techniques to build extraordinary wealth.
Damon Carson is a Longmont business owner. Email him at damon@repurposedmaterials