I’ve written about this before, but it feels timely during a pandemic when folks might be looking at their financial situations with a little more of a critical eye, to circle back to the topic of personal equity, i.e. basically get to talk about Net Worth (again).
Here are common questions I get from readers about equity:
- What is equity?
Equity is just another word for your Net Worth or wealth. It is literally the most important number in your financial life—a figure arguably more important to your overall well-being than your credit score, your bank balance, or even your income. So what is this Net Worth? And how can I get me some?
Equity is literally the most important number in your financial life.
Live Beneath Your Means
- How do I literally calculate my equity?
Easy peasy … presuming you can do some basic calculations (think subtraction). First add up the cash value of everything you own. This is easiest to do for actual cash, things like your checking account balance or the loose change in your wallet. Slightly harder to value are investments such as the amount in your 401(k) or a brokerage account, if only because there will likely be taxes you’ll need to pay if you were to empty these accounts. And you do want the after-tax value. Finally, you have items that have value but perhaps are more illiquid or harder to convert into cash on short notice—things like your car, your home, your stash of lemon-scented disinfecting wipes.
Add all those numbers up. Now make another column on your paper. Here, add up everything you owe. These might include an auto loan, a mortgage, student loans, credit card balances, the next round of drinks when we can all go out again in 2023. Finally, take the total of what you own and subtract the total of what you owe. Voilà! There you have it—your equity! Your “nut” (squirrel or not), your worldly goods, your pot of gold at the end of the rainbow.
You can see read more about Net Worth in this post.
- Why is my equity important?
Let me ask you something. How well off do you think someone who makes $300,000 a year is? How about someone who makes $50,000 a year? What if I told you the former has annual living expenses of $310,000 and the latter has annual living expenses of $40,000?
At the end of the day (or week or month or year), it’s what you keep—after paying the rent on your little patch of Earth, whatever that rent looks like—that determines your financial health. This is why your equity is important. Your equity is what allows you to weather unexpected events (e.g. the year 2020), take advantage of opportunities (you arriving at Costco at the exact same moment as a shipment of disinfecting wipes does), and contemplate a retirement not spent wearing a blue vest greeting shoppers and reminding them to wear a mask (unless that’s what you want to do).
Doesn’t that all sound good?
- Is my equity the only way to think about my value?
Another word for all that you own is assets. And another word for all that you owe is liabilities. Ergo, calculating your equity is subtracting your liabilities from your assets. And guess what? We ALL possess assets and liabilities that are actually not easily translatable to dollars and cents, many of which we did nothing to earn—generational family wealth, good health, rare and sought-after skills, loyal friends always with an open door. Unfortunately, the opposite is also true. In America, some of us carry incalculable liabilities, many also undeserved—the color of our skin, the language we speak, our nation of origin, the god we worship, the responsibilities we carry.
The sociologist William Bruce Cameron notably wrote, “not everything that can be counted counts, and not everything that counts can be counted.” This is true with financial equity, too. When teaching personal finance, oftentimes I stop and remind my students that yes, their equity can technically be calculated, but it is just. One. Number. And it by no means captures the totality of who they are or who they can become.
If anything, these other assets and yes, liabilities, should be added to any honest assessment of your equity. Maybe there’s no actual dollar figure attached to them, but rather than being valueless, perhaps they’re actually priceless.