The Game of Equity
The name of the financial game you are really playing, whether you realize it or not, is the game of Equity.
Equity represents the total sum of one’s financial activity, it encapsulates one’s financial scorecard, and it is the defacto structure of the financial system we all operate in. When it comes to personal finance, Equity is simply one’s Net Worth, and is comprised of one’s Assets, minus liabilities (debts).
Equity = Wealth = Net Worth = Assets - Liabilities
What’s interesting to note here, is that if one has no debts, then Net Worth = Assets.
Assets can be defined in many way, and we dive into this section in depth here (Investments). Regardless of which capitalist system we operate in, the accumulation of assets (i.e. the growth of Equity), is the name of the game.
Capitalism, defined very simply, is a system in which the primary objective is the accumulation of wealth and surplus. The reason? An ever increasing standard of living. So what is wealth exactly?
Wealth can be defined in many ways. Some say health = wealth, and they are certainly correct. Others might say relationships are true wealth, and one really couldn’t argue they are not. However, when it comes to financial wealth Assets and Liabilities are what constitute wealth. As obvious as this may seem to some, most people not only do not realize this, they believe that wealth is a form of lifestyle, i.e. Income and Expenses (mixed with some vague notion of “Savings” and “Investments”). The technicalities and truth regarding wealth measurement, vis-à-vis Equity, is the simple fact that Assets and Liabilities are what count, and what can be counted, in finance.
There are only 4 Asset Classes. That’s it. Simple when you realize it.
All Assets you can possibly think of fall into one of the following 4 Asset Classes:
When contemplating your “Portfolio Diversification” and your “Asset Allocation Strategy” it is so easy to get caught up with all the noise and options available to choose from. However, understanding that contextually, there are really only 4 major choices makes things so much clearer when facing the decision of how and when to deploy your capital. More on this topic in the next chapter.
As individuals we tend to think/ approach debt in order of relevance, in this case:
Real Estate Loans
A common misconception is that “Debt is bad”. The truth is it is a tool, which can be used in various ways. Understanding how the tool works and what task it is meant to accomplish is essential. Not all liabilities are created equally. More on all this in the Credit Section.
Equity in Context
The game of Equity is the Context of Finance. The top of the pyramid. The goal. The win. It is the name of the game we are all playing every single day.
What does winning the game look like? What is the end game? What’s the point of the game?
There is so much unnecessary confusion about how to win in personal finance. Most people call it retirement. The truth is you don’t need to wait till you are 65 to reach the concept of the ‘win column’ in finance. Winning the game of Equity, simply put = accumulating enough assets in order to generate enough income for you to cover your expenditures. That’s it, simple.
The results of a win scenario are, you are free to spend your time as you wish, without having to sell it in order to generate an income to cover you expenses. You also have enough of a “cushion/safety-net” to withstand the unstable waters of life. This is financial control. This is financial freedom. This is what winning the game you are playing looks like. What you do after this point is a different type of game entirely.
FPF EXERCISE: UNDERSTANDING Equity IN MOTION
Play Monopoly. Yes, seriously. Dust off the box and start playing again. Real estate is the easiest way to understand assets and equity, and Monopoly is a great illustration of how to maneuver through financial markets. As you play, contemplate these questions:
After your first green-house (your first asset), you will realize it is a good start, but is it enough to win the game?
What happens to my position if I choose not to buy a house/hotel?
What happens as I accumulate more houses/hotels?
What does my location on the board have to do with my investment strategy?
In order to dominate the game, what are the best moves, and how can they be translated into real life investment strategy?
What happens if I take out too many loans/mortgages?
How can I use loans/mortgages to accumulate more assets?
What does luck have to do with the game, and how do you utilize it to your advantage? How can seemingly random circumstance harm you? Can it strengthen you if you change your strategy? How?