Because billionaires are not made by earning/saving a penny at a time.

They are made from creating something whose value grows rapidly. It can be a company—such as Uber, whose value grew from $0 to $40 billion within five years. It can be an office or apartment building—such as 15 Central Park West or 432 Park Avenue in New York—in an area whose value is rapidly increasing. It can be an infrastructure component—such as a railroad, web service, or telephone network—that enables the rapid creation of a great deal of value  by other people.

One way to create value rapidly is through the concept of leverage. That means using a small amount of money to make a large amount, similar to the way that a lever allows a small effort to lift a large load.

As an example, let's take a real estate development project*. Let us say that it costs $1 million to build a new building. The developer borrows $900,000 from the bank, and puts in $100,000 herself. When the building is finished, it is sold. If it turns out that the market value of the building is $1 million, the bank loan gets repaid, the developer gets back her cash, and no one has made or lost anything. Otherwise, the concept of leverage comes into play:

If the building ends up selling for $1.1 million (only a 10% increase over its cost), the developer pays back the $900,000 loan and pockets the remaining $200,000, thereby having doubled her money.

But if the market doesn't work out as hoped, and the building ends up selling for $900,000 (only a 10% decrease from its cost), the developer has to pay back the same $900,000 loan, and is left with...nothing, having just had her entire investment evaporate.

That's why highly leveraged business investments can both make or lose a lot of money very quickly.

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*For the purists, yes, I realize that this is grossly oversimplified, and doesn't take into account important factors such as interest on the loan, but the goal here is to illustrate the concept of leverage, rather than provide a finance tutorial.

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About Gilang Biantara

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