When most people think about the concept of building equity, they think of home equity. But, in the broader financial context, equity means ownership.
Investopedia defines equity as:
“The value of an asset less the value of all liabilities on that asset.”
So what does that mean to someone who doesn’t own anything of real value? Well, that actually depends on how you define real value. If you’re just getting started in the income earning stage of life, you probably don’t have a home, or even a vehicle that’s worth much – most people’s primary sources of equity. If you do possess either, they’re probably heavily leveraged, so you really don’t own them. And you’re probably years away from owning any kind of investment portfolio.
But what you do have that’s of real value is yourself. More specifically, your capacity to generate income. And the key to building equity in yourself is increasing the gap between how much money you earn and how much you owe. There are two ways to increase that gap, and they really go hand-in-hand.
1. Generate More Income
Most people just starting out face significant student loans and credit card debt – the cost of an education and having a little fun along the way. One step toward building equity in yourself is to generate more income. This could come in the form of working as much overtime as possible at your current job, getting a second, part-time job, or starting your own part-time business. Whatever you choose to do, generating more income is an essential first step in building equity.
2. Pay Down Debt
A common mistake, especially among people in their twenties and thirties, is increasing their debt-load to match their income. For example, earning an additional $500 a month, then financing a new car to the tune of a $500 per month car payment over 48, 60, or even 72 months. The problem with this approach is you’re not only still in debt, you’re deeper in debt.
The more profitable approach is to apply at least part of that extra income to paying down existing debt. For example, if you earn an extra $500 a month, you could apply that to one of your loans or credit cards as an extra payment to principal every month. This would result in you paying that debt off much sooner. Then, rather than adding that extra $500 plus the amount of the minimum payment to your monthly disposable income, apply it all to the next debt as an extra payment every month, and so on. You’ll be truly amazed at how quickly you can eliminate your debt using this method. Soon, you’ll have enough disposable income to not only start a good savings plan, but enjoy some of the finer things in life, and pay cash doing it.
By generating extra income, and applying that income to a debt-elimination strategy, you’ll be building equity in the best asset you’ll ever own – yourself.
Stay tuned for part 2…