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Investing

Use The Rule Of 72 To Your Advantage

The Rule of 72 is a quick way to approximate the amount of time an initial investment will take to double in value. In simple terms, how quickly can a recently graduated, first-time worker turn their life savings ($35 and a soccer ball) into $70 and a soccer ball at differing rates of interest?

My first response would be guess. After that, I’d use the following calculation to figure it out:

Take an investment of $1,000 at an annual interest rate of 8%. Using the Rule of 72, the total time for this investment to double would be calculated as
72 / 8 = 9. In this case it would take 9 years for the $1,000 to become $2,000. This is a very close estimate, since the actual time equals 9.006468 years. That’s the whole rule – nothing short of magic!

How Precise Do You Need It?
For the best results, this rule should be used with percentage return rates between about 5 and 12% Once you begin to go above or below these rates, the delta starts to grow. For example, on a return of 2% the rule calculated doubling time is 36 years; however, the actual time is just over 35. The same goes for a rate of 25% with 2.88 years versus 3.11 actual. I’m willing to let this one go if you know of a lot of 25% return investments in the market!

Compounding and Getting Rich Quicker
Does this make a difference to your everyday life? Probably not, but knowing why it works is a crucial piece of your investment future. The real secret behind the Rule of 72 is not in the ability to figure out your doubling time; rather, it is understanding how compound interest can work in your favor.

Albert Einstein once said:

The most powerful force in the universe is compound interest

Since it’s Einstein mentioning it, let’s take a minute and see how it can work for us.

A Story Of A Rich Guy Giving Away Money

Did anyone ever tell you the story about the person who offers you two choices:

  1. Accept a one-time payment of $1,000,000
  2. Receive one penny today, then receive double the previous day, each day for thirty days (ex. $0.01 today, $0.02 tomorrow, $0.04 next etc.)

Which option would you choose?

Since the first choice is a cool $1,000,000, most people choose it. Easy money…right?

Assuming you can trust the person to continue to pay you everyday, your bank account would look something like this:
(new payment + start balance = end balance)
Day 1 $0.01
Day 2: $0.02 + $0.01 = $0.03
Day 3: $0.04 + $0.03 = $0.06
Day 4: $0.08 + $0.06 = $0.12
Day 5: $0.16 + $0.12 = $0.24
Day 6: $0.32 + $0.24 = $0.48
Day 7: $0.64 + $0.48 = $0.96
Day 8: $1.28 + $0.96 = $1.92
Day 9: $2.56 + $1.92 = $3.84
Day 10: $5.12 + $3.84 = $7.68
Day 11: $10.24 + $7.68 = $15.36
Day 12: $20.48 + $15.36 = $30.72
Day 13: $40.96 + $30.72 = $61.44
Day 14: $81.92 + $61.44 = $122.88
Day 15: $163.84 + $122.88 = $245.76
Day 16: $327.68 + $245.76 = $491.52
Day 17: $655.36 + $491.52 = $983.04
Day 18: $1310.72 + $983.04 = $1966.08
Day 19: $2621.44 + $1966.08 = $3932.16
Day 20: $5242.88 + $3932.16 = $7864.32
Day 21: $10485.76 + $7864.32 = $15728.64
Day 22: $20971.52 + $15728.64 = $31457.28
Day 23: $41943.04 + $31457.28 = $62914.56
Day 24: $83886.08 + $62914.56 = $125829.12
Day 25: $167772.16 + $125829.12 = $251658.24
Day 26: $335544.32 + $251658.24 = $503316.48
Day 27: $671088.64 + $503316.48 = $1006632.96
Day 28: $1342177.28 + $1006632.96 = $2013265.92
Day 29: $2684354.56 + $2013265.92 = $4026531.84
Day 30: $5368709.12 + $4026531.84 = $8053063.68

Did I read this correctly? After 30 days you would have over $8,000,000!

After 26 days you still have less than half the original million dollar offer but four days later, you’re shopping for a new Ferrari.

While the ability to achieve a return of 100% per day is next to impossible, the same thing happens at much lower interest rates. Warren Buffett was able to create his multi-billion dollar fortune by starting with only $100,000 of investor money and finding investments that would give him returns of over 20% per year. Using the rule of 72, Buffett was doubling his investment every 3.60 years and enjoying every minute of it.

A Wake-Up Call
Most people have this idea that they will somehow be able to retire young without actually investing any time or money. If nothing else, let this be a wake-up call for you! The more time you are able to dedicate to your investments, the easier it will be to achieve your retirement goals.

Use the rule to your advantage. Think of it this way, a 20 year old who invests $100 per month until the age of 65 will have approximately $465,000 with an annual return of 8% upon retirement (please don’t think I want you to retire that late or with that little!) If the same person waited until they were 40 to start investing, they would need to invest $529 per month to achieve the same result! If that person only decided to invest the same $100 per month, they would end up with a paltry $87,750. Now who’s happy they spent $3 less per day?

Will this happen to you? I don’t want it to happen to anyone. Use the rule. Retire Rich.

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