Here’s Why Equity Is Everything In Wealth Creation: Definition, Examples, and More
If there exists a single “secret” to wealth creation, this is it:
You must own *equity* to get rich.
What Is Equity?
Equity is just a fancy word for owning a piece of a business. You can get equity in a few different ways:
You can own equity in a business that you start.
You can own equity by buying a piece of a publicly-traded company (a stock) on the open market.
You can own equity in a start-up company that you invest in privately (via Angel.co, for example).
You can own equity in a product or a piece of intellectual property (IP) like a book, script, or other artwork.
And here’s the technical, financial definition of equity from Investopedia:
“Equity, typically referred to as shareholders' equity (or owners equity' for privately held companies), represents the amount of money that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debt was paid off.”
When you own equity, you have a “right” to the assets of the business. Your piece grows as the business grows.
Those who are already rich take equity very, very seriously. The late millionaire, Felix Dennis, writes in his (excellent) book, How To Get Rich:
“Please think about this if you want to be rich. Ownership is not the most important thing. It is the *only* thing that counts.”
Here's why Equity Is Everything:
It compounds your money.
It disconnects inputs from outputs.
It gives you unlimited upside.
It means no one can replace you.
It means you own the risk.
It buys you freedom of your time.
Equity Compounds Your Money.
When you own a piece of a business, the business compounds your money by reinvesting any interest or earnings it generates to create even more gains on top.
So not only are you compounding your initial investment. You are also compounding all the interest or earnings you accumulated in the past.
This is called compound interest.
The sooner you can hammer into your skull the power of compounding interest, the richer you are going to be.
Remember, compounding interest is when you make money off your original deposit, plus the interest on that deposit.
So if I deposit $10 and get a 5 percent annual interest rate, after one year, I have $10.50. After year two, though, I've not compounded $10. I've compounded the $10.50 - giving me $11.03 total after two years. After 40 years, that $10 has turned into $70.
Play with the math yourself. You'll realize that if you can own equity in a great business to compound your money at a high rate of return for 30+ years, you will become rich.
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
Equity Disconnects Inputs From Outputs.
Angel investor, Naval Ravikant, explains that equity decouples your inputs from your outputs in your career.
When you work a salaried job (paid by the hour or by the year), your input (8 hours / day) is directly connected to your output (your salary).
Equity severs this relationship.
For example, if you’re an investor in public companies, you could spend 1,000 hours (input) researching one publicly traded stock to buy. Then, when you buy it, your return could be zero or even worse. You’ve done a bunch of work for free.
Or, you could spend five minutes researching a stock, buy it, then make 100% on your investment a month.
Your results are disconnected from the hours you put in.
You don’t even have to be awake and working to make money. All of your gains could occur while you’re asleep.
When you own equity, you decouple the outputs from the inputs.
Inputs & Outputs In Creative Careers.
In my business, I write treatments (creative proposals) to pitch to clients. The amount of time I spend on the proposal (input) is disconnected to the output.
I could spend 10-minutes on a simple, one-page proposal that leads to a deal worth hundreds of thousands of dollars. Or I could spend 20-hours building a colorful PowerPoint presentation that leads to nothing.
My wife is an actor. These same rules apply to her career. She could spend 10,000 hours in acting classes working on her craft, and still not book a job for a year.
Or, she could send in one self-tape audition that took 30-minutes to record, and it changes her life with a big, blockbuster movie.
It’s not a coincidence that both my wife’s career and mine function like this.
We both work in a creative field, and Ravikant points out that creative professions tend to have inputs that are disconnected from outputs.
When you own equity in the product (like a treatment or an acting performance), it doesn’t matter how many hours you put it to create it. The output can be many times larger than the input.
Digital products Disconnect Inputs and Outputs, Too.
The same is true for a digital product (a form of equity) that you sell on a platform like Gumroad, for example.
Whether you spent five hours or one thousand hours creating the product, your input doesn’t determine how much money you’ll make from it.
You could make $100,000 off of something you put together in a week.
Equity Gives You Unlimited Upside.
When you work in a salaried position, your upside is limited to a yearly salary or an hourly rate.
Sure, you may get a nice bonus at the end of the year, but ultimately your upside is capped because the input (the hours you put it) matches the output (your hourly wage). There’s no additional upside potential.
Owning equity in a business means that there’s no cap on your upside because your piece of the pie grows at the same rate as the business.
A stock you own like Apple or Amazon or Google has no capped upside. The price and value can continue to rise with the growth and profitability of the company. The business (and stock price) is capable of growing at 5% per year or 100% per year. And your piece of equity grows as the business grows.
If you run your own company, you get to keep what’s left after you pay out your expenses. There’s no hourly wage or yearly salary to cap your earning power. You have unlimited upside potential based on the performance and growth of the business.
Equity Means No One Can Replace You.
Naval Ravikant tells us that when you own equity, it’s a lot harder to be replaced by someone else compared to a salaried position.
A job with an hourly wage precisely matches the input with the output. You are doing the same task or the same set of tasks repeatedly. Someone else can be taught to do the job, just like you were taught to do it.
But with equity, you are an owner. You share in the brand, product, business plan, or IP in exchange for risk and accountability. You are not renting out your time. Instead, you are sharing in the upside (and downside) of the business you help bring into existence. This makes it harder for someone else to replace you.
Equity Means You Own The Risk.
With great upside potential comes great downside risk.
Ravikant reminds us that if you are an owner, you get paid after everyone else. That’s great if the business is profitable. But if there’s nothing left of the pie by the time you’ve paid all your expenses, debts, and employees - too bad. You get nothing.
There’s no ownership without risk.
But it’s worth it in the end because:
Equity Buys You Freedom Of Your Time.
Time is everything. It’s your most important non-renewable resource. Once it’s gone, it is gone for good.
You can always make more money, but you can’t get back your time.
I recently saw Charlie Munger speak in person. It was one of the highlights of my life. He is 96-years-old, incredibly lucid, and extremely rich.
If he could switch lives with me this instant, do you think he’d do it?
It’s possible that he would. He can buy anything he wants on earth, but it’s time he can’t get back.
Charlie Munger at the 2019 DJCO annual meeting (photo by me).
Equity buys you freedom of your time.
When you own equity, it doesn’t matter how many hours you put it.
What matters is how much someone is willing to pay for the thing you’ve created. You can make money while you sleep, sit on the beach, meditate, or work out.
The late millionaire Felix Dennis writes in his book, How To Get Rich, about what money meant to his life. This excerpt strikes me:
“And just what is the most precious thing in life that riches can supply? Easy. For me, it’s Time.
Time. Time to read and write poetry if I want to. Or to write a book if it takes my fancy. Time to travel on the slightest whim, to walk in the woods, to think, to commission art, to read, to drink, to hang out with friends and loved ones...to do just about anything really…
That’s what money can do.”
Freedom of time and freedom of thought is what this journey is all about.
Start Building Equity Now.
Start a business.
Buy stock.
Purchase real estate.
Write a script.
Create digital media.
Make videos.
Collect as much equity as you can in every part of your life.
If you do this and wait long enough, you’ll get rich.
Start now.
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Dennis, Felix. How to Get Rich: One of the World's Greatest Entrepreneurs Shares His Secrets. Penguin Publishing Group. Kindle Edition.
Read Naval Ravikant’s entire podcast on “How To Get Rich” here: https://nav.al/rich