The rule of
72 is even more important than the theory of relativity, Albert Einstein used
to say. The first reference to
this rule is attributed to Luca Pacioli who is considered the "Father of
Accounting". He explains the importance of this rule in his 1494 book
Geometria, Proportions, and Proportionality.(Summa de Arithmetic, Geometria,
Proportiono et Proportionalita)
Being able to double your money in a short time is everyone's dream.
Number 1. The Rule of 72
The Rule of 72 has several applications such as setting financial
objectives, analyzing economic trends, planning financial goals, evaluating
investments and it can also help you analyze debts.
The way it works is simple, it consists of determining how long it will
take to double an investment by receiving a fixed interest rate.
Here's how you calculate it: Take 72 and divide it by the interest
return you expect to earn. For example, if you plan to earn 5% interest divide
72 by 5. This will give you 14.4. This is the number of years it will take you
to double your investment.
There are many advantages to be gained by using this rule, for example,
you can quickly and easily determine if you are on the right track, which is
crucial when the time comes to make financial decisions.
It is also useful for calculating inflation, since it tells you how many
years it will take for the value of the initial sum to LOSE ITS VALUE and half
its value, instead of doubling.
Having said all this, it is important to note that the rule has its
disadvantages. For example, it is only applicable for assets that calculate
compound interest annually.
This Rule also has some accuracy problems because it does not apply to
rates below or above 6% and 10% respectively.
However, don't let these disadvantages keep you away from the Rule of
72. Contact your trusted financial advisor for a detailed explanation of this
rule and proper guidance.
Number 2. Compound Interest
As I mentioned before the rule of 72 is only applicable with compound
interest, when you understand and assimilate the rule and the power of compound
interest, you will have the recipe for economic growth.
Having explained the rule in detail, let's next talk about compound
interest. The great thing is that the longer your money is invested, the higher
your earnings will be.
Specifically, the interest earned on your initial investments is added to
your initial investment and so the cycle continues. Basically, re-invest your
money in the initial investment and then forget about it.
Now, if you are interested in knowing how long it will take you to
double your current savings, use the rule of 72. Take your interest rate, say
6% and divide it by 72. 72 divided by 6 gives us: 12 This is how long it will
take you to double your money at that interest rate. When it comes to compound
interest look for an asset where the interest rate is high, because the higher
the interest rate, the faster you will double your money.
Contact your trusted financial advisor, ask about compound interest and
use the rule of 72 to find out how fast your investment can grow.
Number 3 Investments
The rule of 72 is also useful for evaluating your investments. Sooner or
later there comes a time when we all want to make investments and you can
definitely use this rule to get a clear idea of how long it will take for your
money to double.
Additionally, if you are thinking of investing, the rule of 72 can help
you calculate how long it will take before you receive a 100% return on your
investment.
Whatever investment you make, the rule of 72 will help you as long as
you also include compound interest, don't forget!
As an example for this rule, let's look at the detail of the following
scenarios:
Investment No. 1: Savings deposit with at 1% annual rate of return
Investment No. 2: Government bonds at 5% annual rate of return
Investment No. 3: Mutual funds with at 7% annual rate of return
Investment No. 4: Stocks with at 11% annual rate of return
Next, using the rule of 72, try to calculate for yourself how long it
will take you to see a return on these investments. Write your answers in the
comments and mention which pattern you can see.
Number 4. Inflation Rate
You may hear on the news that there is currently inflation. But what
does this really mean? The inflation rate is the rate at which prices tend to
increase over a specific period of time. Things like household goods and
services, for example, are affected by the rate of inflation. Specifically, it
is more expensive to buy the same thing I bought last year these days.
The rule of 72 is useful to determine how long it will take to overcome
inflation. If, for example, inflation averages 3% per year. Doing the math we
find that the price will double in the next 24 years. However, if the inflation
rate remains at 6%, 72/6 gives us 12. So in just 12 years prices will rise
dramatically. Using this rule, you can plan your finances in advance to prevent
inflation from hitting you.
Number 5. Savings
This rule has many uses, including when talking about savings, it will
help you project how long it will take for your savings to double.
When you think of savings, what is the first place you think of to keep
your savings?
Keep it at home? It's too risky and too easy to lose.
In the stock market? Well ... that's more likely to make your money
grow, but also with a high chance of loss. Then maybe open a savings account at
your local bank. If you are lucky here, you might earn 1% interest on your
savings account. And let's be honest, it's usually the easiest thing to do.
Setting a savings goal is great and setting a savings budget is also a
good idea. But you should also know how long it will take to double your
investment.
So, let's look at some examples using the rule.
72 divided by the rate of return equals the time it takes for the
investment to double.
Example, let's say you have $1000 that you want to save in the bank.
Let's say you will earn 1% interest rate per year. So 72 divided by 1% = 72
Years. That means if you put $1000 in a bank now, you can expect to have $2000
in 72 years! But I'm pretty sure you won't be around in 72 years to make a
profit of $1000. Is that understood...?
Just do a little research and you will find that there are many
investment programs available that guarantee a minimum interest rate of between
4% and 7% per year. Contact your trusted financial advisor and they will show
you much better routes you can take. That said, let's use the same example as
above: You still have the initial $1000 for your investment but now you will
allocate it to an index savings program with a guaranteed interest rate of 5%
per year. Therefore, 72 divided by 5 = 14.4 years. So, instead of waiting 72
years, it will only take you 15 years to double your investment with whatever
amount you invest. And it's safe! In the long term it is effective. The 5% is
just an example, the real rates can be higher.
Conclusion:
The rule of 72 is a numerical calculation that can be very useful in
identifying many things. With it you can see how long it will take for your
savings to grow or how much money you will have to earn to stay ahead of the
inflation rate. The common denominator of all the things we can use the rule
for is LEARN to be patient.
The sooner you start your journey to financial freedom, the less
you have to be patient and wait. Take action.
I hope that what you have learned in this Article will be useful, tell
us in the comments how you will use this rule.
Have a nice day …. see you next time.
