“I love saving money!” – Said almost nobody…ever.
The fact is, what is the point of having a lot of money if you don’t use it to purchase anything? I believe that a lot of people don’t get the most out of their personal finances because they think the only way to grow their wealth is by “saving money” which is a very boring and uninspiring concept. So don’t “save money”! Use it to purchase “equity”!
In it’s most basic definition “equity” is “the quality of being fair or impartial”, and in finance “equity” is defined as what is left when all of the assets of company are sold and debts paid, but to me the concept of financial “equity” is much simpler – equity is “ownership” and can often be thought of as a percentage of ownership in an asset (for our purposes here lets define an “asset” as something that bears interest or grows in value over time: in most cases things like cars and clothes are not assets : )
Let’s say you have a savings account that has $10,000 in it. As the sole owner your “equity” in that asset is $10,000 or 100%. This is great! But 10,000 one dollar bills will always only be worth 10,000 one dollar bills (plus a small amount of interest), and dollar bills generally only become less valuable over time. This begs the question: how much would that $10,000 be worth if you purchased equity in a different asset instead?
Here’s an example: You buy a house for $100,000 and put down $20,000 as a “down payment.” What is your equity? Well…$20,000 or 20%. At this point the lender essentially owns the other 80% of the property, but as you pay down your loan your ownership increases and the bank’s declines. As an experiment lets say the value of the property then jumps to $150,000 overnight (purely hypothetical). Your equity is still 20%, so the value of your ownership is now worth $30,000.
Let’s take a real world example. The median sale price of a home in Los Angeles is $750,000 as of August 2020. Last year the median sale price was closer to $645,000. This is about a 14% increase in real estate values in one year. So if you had $100,000 in “equity” in a $645,000 home August of 2019, that “equity” would be worth $114,000 this year! How much would that savings account have been worth with $100,000? Likely somewhere around $100,800.
The point here is that “equity” is an ownership piece of an asset. It’s how much of that asset you own, and as a percentage it stays the same as the value of the asset grows. These assets can be any number of things including stocks, bonds, commodities like gold, businesses, and even art and sports cards. While you may not be able to wear your “equity” on your back or drive it to the grocery store, your “equity” makes you money while you sleep over time. In addition, equity is something that is bought (whether with money or with “sweat”) and I believe getting to buy something and own it is a whole lot more exciting than “saving money” and can psychologically make it much easier to prioritize wealth building rather than frivolous expenditure.
By purchasing “equity” in valuable assets and owning them for long periods of time, these assets grow in value and your ownership share becomes more and more valuable without you having to lift a finger! This is how fortunes are made: by owning equity in valuable assets, not by “saving money”!
- Gabe
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