“The only question with wealth is, what do you do with it?”
John D. Rockefeller
Equity is the difference between assets and liabilities.
In personal finance, you could look at equity as personal worth using the formula: Assets – Liabilities = Equity.
The most common and basic way to break down this formula is by looking at your home. Your home is an asset, because you can sell it on the market in exchange for money. Your home loan is a liability, because you paid a small amount to borrow money now to buy your home and you must pay it back later. Equity is the net value when you subtract your home’s value (asset) from your home loan (liability).
Home Equity
Let’s look at the COVID-19 pandemic and the housing market. During this period, the value of homes surged dramatically as the cost to borrow money decreased with historically low interest rates.
As an example, say you bought a home in Idaho for $500,000 in 2015. Your home’s value could have jumped to $700,000 in 2020 (a 40% increase or more depending on where you lived). If you borrowed 80% of the cost of your home in 2015, then you had a liability of $400,000. If you made $75,000 in mortgage payments, the equity in your home in 2020 would have increased to $375,000 from $100,000 in just 5 years. Your home’s equity means if you paid off the balance owed on your mortgage ($325,000) and sold your house for $700,000 then you would have $375,000 in cash.
There are many ways to unlock or tap into the $375,00 of equity in your home to get more money in your pocket. For example, you could get a Home Equity Line of Credit (HELOC), which you could use to renovate your home, start a business, send your kid to college, or to consolidate credit card debt.
| 2015 Value | 2020 Value | |
|---|---|---|
| Home (Asset) | $500,000 | $700,000 |
| Loan (Liability) | $400,000 | $325,000 |
| Equity | $100,000 | $375,000 |
In corporate finance, equity is the market value of the assets owned by shareholders after all debts have been paid off. In accounting, equity refers to the book value of stockholders’ equity on the balance sheet, which is equal to assets minus liabilities. Private equity (or PE) means that a company has direct investments made into them by a firm or investor, and they are not publicly held. In a publicly traded company, each share has the same rights as all others, hence equity meaning “equal”.
Equity in a Public Company
For example, popular platforms like Discord and Reddit are rumored to issue IPOs (Initial Public Offerings) or “go public” in 2022. This means they will be owned by anyone (the public) who buys a share through the NYSE or NASDAQ stock exchange. A company like Reddit will issues shares. These are equity stakes in the company and Reddit can pay you back the profits they retain after substracting their debt from their assets. Positive net profit could make stock value increase and investors may receive a dividend. On the other hand, as an investor you’ve also assumed the risk with the reward. Because of this, the stock stands to lose value and you may lose money if Reddit performs poorly in the market.
Lumen sums it up well: “You can buy capital from other investors in exchange for an ownership share or equity, which represents your claim on any future gains or future income. If the asset is productive in storing wealth, generating income, or reducing expenses, the equity holder or shareholder or owner enjoys that benefit in proportion to the share of the asset owned. If the asset actually loses value, the owner bears a portion of the loss in proportion to the share of the asset owned.”
For a more advanced financial approach, you can look forward by using a discounted cash flow model (DCF) to calculate net worth. Check out this spreadsheet (via CFI) for both methods.
