The Three Big Tools
For Growing Your Wealth
Pat Brennan | February 10th, 2021
One of the most powerful yet simplest thoughts I’ve ever heard regarding saving and investing is to “pay yourself first”—the first big tool. This simple idea is really a mindset. It reflects a commitment to set aside, every month, a planned amount of money for savings, investments, retirement accounts, college savings accounts, or funds set aside for more specific financial goals. Of course, in order to pay yourself first every month, you must spend less than you make and then have a plan to save and invest the difference. I can’t emphasize enough that a little patience and discipline is necessary to get ahead. The ability to forego unnecessary purchases or luxuries is a necessity for most of us if we wish to build wealth.
When I entered the workforce out of college, I lived a sort of hand to mouth existence. My first objective was to acquire some basics like furniture and other items for a comfortable apartment. After I had the basics and got my first pay raise, I then felt I had enough income to begin to pay myself first. After every promotion and pay raise my family and I lived better, but we also increased our monthly savings and investments. Because I was content living at my income level before every raise, I never felt the need to spend much of the increase on a more expensive lifestyle, thus most of the difference was saved. So, the key to paying yourself first is to work out a budget with a steady, reliable surplus and save and invest a certain amount, automatically, every month. Over time, you’ll never really miss the funds and seeing your accounts grow can be a very rewarding.
Our second big tool is dollar cost averaging, the practice of investing the fixed amount, regularly, over a long period of time. This tool works seamlessly with our first tool, pay yourself first, by giving you a method to do so regularly and consistently. The reason why dollar cost averaging works so well, especially in equity funds whose value fluctuates over time, is it allows you to buy more shares when prices are low and fewer shares when prices are high. By doing so, you to take advantage of dips or declines in the market lowering your average cost per share.
Let’s take a look at a simple example to see how dollar cost averaging can work to your advantage over time, especially during a recession or difficult times for the stock market. I’m going to use the iShares SPY exchange traded fund (ETF) as a proxy for the S&P 500 market index. In October of 2007 the stock market reached a peak and would drop precipitously as the nation fell into the throes of 2008 financial crisis. The market did not claw its way back to its 2007 peak until April of 2013. That’s a long time to be in the doldrums and it hurt many who retired in between 2007 and 2009, or needed to pull money out of equity funds to pay for college, etc. At one point, the S&P 500 had dropped more than 50% from its peak. That hurts. Those who had a long-term horizon and were able to continue buying shares harnessed the power of dollar cost averaging to profit from the situation.
As a simple example, let’s say we started investing in the SPY in October of 2007 and invested $1,000 every October for 7 years. Here’s what might have occurred in our account:
| Date | SPY Price | Amount Invested | Shares Purchased |
| 10/22/07 | $ 149.67 | $ 1,000.00 | 6.68 |
| 10/20/08 | $ 87.04 | $ 1,000.00 | 11.49 |
| 10/19/09 | $ 108.08 | $ 1,000.00 | 9.25 |
| 10/25/10 | $ 118.49 | $ 1,000.00 | 8.44 |
| 10/24/11 | $ 128.60 | $ 1,000.00 | 7.78 |
| 10/22/12 | $ 141.35 | $ 1,000.00 | 7.07 |
| 10/21/13 | $ 175.95 | $ 1,000.00 | 5.68 |
| Total | $ 7,000.00 | 56.40 | |
| Avg Cost per Share | $ 124.12 | ||
| Value on 10/22/13 | $ 9,922.95 |
Because we purchased most of our shares as the market declined and slowly recovered from our initial investment price, we acquired our shares at a reduced average price compared to investing $7,000 at the outset. Here is a graphical depiction of the share price over this period:
As you can see, as the price declined you bought more shares for the same dollar amount invested. When the market recovered, your reduced average cost per share allowed you to profit from the dip. In a way, it’s sort of magic because it allows you to set up a simple investment plan that will allow you to take advantage of the market’s fluctuations. Here is another chart of this example financial condition over time:
This chart shows how your wealth may have accumulated over time and the effect of dollar cost averaging into a declining and recovering market. Of course, if the market rose during this period and later fell, your average cost per share would have been more than had you invested all your money up front. Fortunately, the market tends to trade lower than a previous high about 95% of the time. Again, long time periods work to your advantage.
Time brings us to our third big tool–compound interest. If compound interest were a natural wonder it might be the world’s 8th because its power in growing your assets over time is truly astounding. Let’s look at a few examples of how compound interest, over long periods of time can have an amazing effect.
In this example we’ll look at how much a woman would accumulate by the age of 60 if she invested $300 per month, starting at age 25, age 30, and age 35, an IRA equity fund averaging 5% over the life of the fund.
Age 25: $322,540
Age 30: $244,617
Age 35: $175,723
The person with the ability and discipline to start investing earlier and hang in there over time accumulates a great deal more. And again, it’s the magic of compound interest, over long periods of time, that does so much of the heavy lifting here. Although between the ages of 25 and 30 our investor would have contributed only $18,000 into her fund, by age 60 she’ll have $77,923 more than if she started at age 30—all because she started 5 years sooner. Start saving as soon as possible by putting away whatever you can towards retirement, savings, and college funds and you’ll end up making your goals much easier to attain.
I started investing in equity mutual funds when I was about 26 years old. I began by putting some money each month into an IRA and taxable account. I also started a college savings fund (Coverdell Educational Savings Accounts and later 529 accounts) for each of my four children when they were born in order to take advantage of dollar cost averaging and compound interest. As a person with a steady income but not a much wealth to speak of, I paid myself first, dollar cost averaged into equity funds, and started as soon as I could to compound that money for as long as possible. It’s really that simple. If not doing so already, I would encourage you to do the same thing. You won’t regret it.
Onward,
Pat Brennan
Pat Brennan is the founder of bucksandparks.com
Copyright 2021. All rights reserved.
