Most investors think "leverage" is a dirty word.
If you trade on margin (borrowing money from your broker to buy more stock), you are playing a dangerous game. One market dip, and you get a margin call. Your positions are liquidated, and you are left with nothing.
But here is the confusing part: Warren Buffett uses massive amounts of leverage. In fact, for every $1 of his own shareholders' money, he often invests significantly more.
So, why is he the Oracle of Omaha while margin traders are losing their shirts?
The answer lies in a specific type of leverage called The OPM Factor (Other People's Money).
1. The Magic of "Float" ✨
Buffett doesn't borrow from banks. Banks charge interest and demand repayment on strict schedules. instead, he borrows from his insurance customers.
Here is how it works:
When you buy car insurance, you pay the premium today. However, you might not get into an accident for ten years (or ever). In the meantime, the insurance company holds your money.
This pile of cash is called "Float."
To a standard insurance company, this is just a reserve. To Buffett, this is free money. He takes these billions of dollars in premiums and invests them in the stock market.
The Retail Investor: Borrows at 8% interest to buy stocks. Needs high returns just to break even.
The Buffett Way: Gets paid to hold the money (via insurance premiums) and keeps all the investment upside.
His cost of borrowing is actually negative. He is effectively being paid to take a loan.
2. Being the House, Not the Gambler 🎰
Berkshire Hathaway specializes in "Super Cat" (Super Catastrophe) insurance. These are policies that cover massive disasters, like a mega-earthquake in California or a hurricane in Florida.
This sounds risky, but it is actually pure mathematics.
Buffett acts like a casino. He knows that a specific disaster might happen once every 50 years. He prices the insurance premium as if it will happen every 20 years.
If the disaster happens: He pays out, but he has the capital to survive it.
If the disaster doesn't happen: He keeps the massive premiums as pure profit.
Because he has so much cash on hand, he can take bets that no other company can afford. While competitors panic over a bad year, he uses that fear to charge higher prices for protection.
3. The Tax "Loan" 🏛️
There is another hidden form of OPM in his strategy: Deferred Taxes.
Buffett is famous for holding stocks for decades. When your portfolio goes up in value, you owe taxes on the gains. But you don't have to pay them until you actually sell the stock.
If you hold a stock for 30 years, you are essentially keeping the money you owe the government and investing it for yourself that whole time. It is an interest-free loan from the IRS that compounds year after year.
The Takeaway for You
You might not own an insurance company, but you can apply these principles.
Avoid Toxic Debt: Never borrow money that can be called back during a market crash.
Patience is Profit: Holding quality assets for the long term creates an "interest-free loan" through deferred taxes.
Look for Structure: When analyzing companies, look for businesses that get paid upfront but deliver the service later (like subscription models or insurance). They are sitting on a goldmine of float.
Investing isn't just about picking the right stock. It is about structuring your wealth so the math is always on your side.
I’d love to hear from you: Do you look for "float" when you analyze stocks, or is this the first time you’ve considered it? Let me know in the comments!
Stay calm and compound on,
William