Rule Of 72 Formula
Posted By tsauthor on November 20, 2009
The Rule of 72 is a nice little mathematical formula that shows you how fast your money will double, based on the rate of return (interest rate) of your money. This is how it works. You take a particular interest rate and divide it into 72 and that will tell you approximately how many years it will take your money to double. For example, if you were making 36 % (that?s not bad) on an investment, then [72/36 = 2] your money will double every two years.
Why is this rule important?
When I entered the financial services industry, I saw an illustration like the one that I am about to show you. It blew my mind because I didn’t realize that a few percentage points on an investment could make such at big difference over the course of several years. You see, most people are taught by their parents to save money. Saving money for an emergency is a smart personal finance budgeting move, but saving money for retirement is the worst thing you can do!
Consider the amount of interest your money makes in a bank. 1-2%? Let?s say that it was 2%. [72/2 = 36]. This means that if you put $10,000 in a bank, in THIRTY SIX years it would be $20,000. A lot of people don’t even have $10,000 dollars lying around to invest, but if you did, putting it into a bank to save would get you broke! Keep in mind that inflation is supposedly 5% (It?s really closer to 10%). So how does this compound interest work?
The Illustration
Now that you are knowledgable about what the Rule of 72 is, we can move on to an illustration to demonstrate how powerful it really is. We will use this experiment on a man named Darrell. Darrell, on his 18th birthday receives $2,000 from his parents and is told that this money MUST be used for his retirement. He takes his $2,000 to the bank and they tell him to put that money into a savings account and they will guarantee him 3%. This is more than you will get in most places so he jumps at it. [72/3 = 24]. So, Darrell?s money will double every 24 years. Darrell wants to retire at age 64 (48 years later).
Scenario #1
With the 3% that Darrell is making, his money will grow as follows. After:
24 years = $4,000 >>> 48 years = $8,000.
Final Amount = $8,000.
SO? after 48 years, Darrell is now 64 years old, and he has $8,000 to collect from the bank to retire. Good luck.
Scenario #2
Let’s say on the other hand that Darrell decided on the other hand to put that $2,000 into a CD that was paying 6%. [72/6 = 12]. Darrell?s money will double every 12 years! So This means that Darrell’s money will grow twice as fast right? Well, let?s see. After:
12 years = $4,000 >>> 24 years = $8,000 >>> 36 years = $16,000 >>> 48 years = $32,000.
Final Amount = $32,000
You see, by doubling his interest rate, Darrell would actually quadruple his money over 48 years. But, $32,000 isn?t that much. Forth-eight years from now it may only get you a full tank of gas!
Scenario #3
Let?s say that Darrell is proactive and decides to put his money in the stock market. He does some research and finds some good solid funds that pay 12%. [72/12 = 6]. So Darrell?s money will now double every 6 years! Maybe he will quadruple his money again! Let us see. After:
6 years = $4,000 >>> 12 years = $8,000 >>> 18 years = $16,000 >>> 24 years = $32,000 >>> 30 years = $64,000 >>> 36 years = $128,000 >>> 42 years = $256,000 >>> 48 years = $512,000.
Final Amount = $512,000.
To get the rest of this article you can go to How Does Compound Interest Work? You can also subscribe to the free monthly newsletter and get valuable information on personal finance.
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