When people say that they buy a house to build equity, what does it mean? If you treat your personal finance as a business and look at it through your personal income, balance sheet and cash flow statements, it will make sense.

Balance Sheet

Equity is the difference between assets and liabilities (debts). Assets include cash, marketable equities which can be liquidated quickly, and fixed assets (cars, houses, land for instance). You can choose to hold a lot of cash, invest in stocks or buy a house. If you hold a lot of cash on hand, your investments will be $0. This method offers assurances, but loses purchasing power due to inflation.

If you decide, for instance, to invest 50% of your cash into stocks, your cash will dwindle by 50% while you have a number show up on the investment line item. Having less cash can feel less secure, but your investment can help offset the sting of inflation.

If you buy a land without a loan, your cash balance will be $0, but now you have a number on the fixed asset line item.

What if your desired investment is bigger than your assets? The usual solution is to get leverage, aka a loan or a mortgage. For example, you have $100,000 in cash and you want to buy a house at $300,000. What typically happens is that you pay $60,000 down payment and get the rest from a lender. This loan will show up on the Liabilities section. Hence, even though your assets increase over night, so do your liabilities. As a result, your equity generally doesn’t increase the moment you move into a new house.

Here is a simple illustration that compares the four scenarios above:

Apart from hoarding cash, every investment decision is made with the intention to grow assets faster than debts. With marketable securities, it depends on what you buy. An index like S&P500 will fluctuate over the years, but in the long term, historical data shows that it can earn a very decent return. Individual stocks or cryptos can yield higher returns, but at the same time, are also much riskier. These securities will change the “Marketable Securities” line item on your balance sheet, but they won’t turn into cash until liquidation.

With houses and land, their value tends to fluctuate less than stocks or cryptos. Home/land owners can periodically use online tools to check the value of their investments. Over time, such value tends to go up while mortgage is gradually paid down, probably leading to the increase in equity. I said probably because unlike stocks, owning a home can affect your cash.

Income Statement

Most of us have a 9-5 job that pays our bills. After taxes, HSA and 401k contributions, we receive a net bi-weekly paycheck. That’s our gross income. Then, we pay for our expenses like rent, cars, insurance, food, education or transportation. If you own a home, your monthly expenses will also include housing taxes, HOA, insurance premiums and depreciation.

Whatever is left is operating income.

The next items are interest expense, other revenue/gaines and other expenses/losses. If you have a mortgage, the mortgage payment is booked as interest expense. Any realized gains (dividends or investment gains) or realized losses (stocks sold below cost) are also booked accordingly. After all that, you are left with net income.

Owning a home will elevate your monthly expenses and affect your cash. Sure, regular purchases of stocks will also affect your cash, but the difference is that while you can choose not to buy stocks in a certain month, you are always required to pay housing-related expenses.

Overall, I consider home ownership a personal decision more than an investment. If your intention is to maximize returns and build equity, few options can beat owning stocks in the long term. However, owning a home is not just about financial returns. It’s also about giving your children a home to grow up into, being to build your dream home, doing what you can’t in a rented place etc…I hope people don’t buy a home simply because that’s the beaten path and because people implore them to “build equity”. There are other ways to build equity and what worked in the past may not work nowadays.

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