The Rule of 72
The rule has long been used in finance to help someone determine a very close estimate of how long it will take for their investment to double in value. This is often used when you are planning for retirement, long term goals, short term goals, and for business investments to increase cash flow and open up more opportunities.
The rules states the following: Take the fixed average interest rate that you would receive and divide 72 by that number.
Certificate of Deposit (CD). earning 2.5 percent for the next 5 years.
You reinvest your earned dividends and capital into it until you reach
your goal. You have $1,000 to invest in the account in a lump sum
amount. Next, Divide 72 by 2.5 percent= 28.8 years doubling period.
In 28.8 years or the end of 2050 your investment would be worth
A part of a financial freedom plan must include a way for your money to work for you and make you more money! Without this you are simply saving and never reaching your true potential.
The rule can be used anytime you are planning for a financial goal and want to know the time period that it will take for your interest bearing investment to help you reach that target. Remember that if your money is not working FOR YOU then it is working AGAINST YOU because INFLATION=ECONOMICS.
Definition- a general increase in prices and fall in the purchasing value of
You may be asking yourself, How does compound interest work and why should I care? Why should I be thinking about inflation?
Simply put, compound interest is the most powerful thing that mankind has ever experienced in my opinion. You invest your money and the interest earned gets reinvested on top of your initial $ amount to earn you more money every single period. Not only are you always earning money on your initial investment, but your gains are also working for you and earning money each and every time you receive them.
Example: You are 25 years old. You invest your money into an S&P 500 ( Standard and Poor's) index fund that tracks the average returns of the top 500 companies in the U.S. and earn an average of 10 percent on your money. Your initial investment in a lump sum investment (invested all at one time) is $15,000. When you retire at age 65 you will have roughly $617,172. This assumes you invest $15,000 when you are 25 and never invest another dollar there after.
Disclaimer!! - This was calculated using financial software.
Calculation included 3% inflation, 4 % rate of return in
retirement, and a 10 % historical annualized rate of return on
the S&P 500 Index Fund. This is not investment advise! Please
consult a financial advisor or planner to discuss your unique
needs and receive advice. Thank you.
Can you now see why it is important when calculating for growth and compound interest that you need to take into consideration for inflation, the rule of 72, and your time period until retirement or your financial goal?
As we discussed previously in our other blog, money has a time value, there is a risk vs. reward tradeoff, and you need to protect yourself and your Squad of Money. using this method will allow you to actually calculate your goals using a financial calculator and various other methods and stay on track to reaching Freedom!
***Important Note**- Do not guess when it comes to your financial plan. You need to take the time to accurately calculate your time period, desired interest rate, and the risk involved in every situation. Always look at other opportunities and create a Pros vs. Cons list for each one. This will allow you to see your opportunity cost in a T chart to make the most informed decisions. ***
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CEO Elevation Solace LLC
Neuro-Transformational Financial Coach