Rule of 72
Albert Einstein said that compound interest was the “greatest mathematical discovery of all time.” Einstein is credited with discovering “The Rule of 72”. Some people believe that the Rule of 72 is the key financial success; the most important financial concept to understand and practice.
Money experts use the Rule of 72 on a daily basis. Some financial institutions want you to understand the Rule of 72 so you’ll make wise decisions regarding spending and investing. Other financial institutions probably wouldn’t mind if you never learned the Rule. They’re making lots of money charging you interest on your credit card balances.
Step 1: How long does it take my money to double?
This step teaches you how to determine the number of years it will take for your investment or debt to double in value.
Divide the number 72 by the percentage rate you are paying on your debt, or earning on your investment. Here are two examples…
You borrowed $2,000 from your friend, who is charging you 6% interest. 72 divided by 6 is 12. That makes 12 the number of years it would take for your debt to your friend to double to $4,000 if you did not make any payments.
You have an investment account with $2,000 deposited in it. It earns 8% interest. 72 divided by 8 is 9. It will take 9 years for your $2,000 to double to $4,000 if you don’t make any additional deposits.
Remember: 72 divided by the Interest Percentage is the number of years it takes to double.
Step 2: How many times will my money double?
This step teaches the importance of doubling your money as many times as possible.
Determine how many years you will keep your investment before cashing it in. Divide that by the number of years it will take to double each time, the number you figured out in step one.
Now look at what happens to your money each time it doubles…
$1 … $2 … $4 … $8 … $16 … $32 … $64 … $128 … $256 …$512 … $1,024 … $2,048 …$4,096 … $8,192 … $16,384 … $32,768…
It makes a difference how many times your money doubles. The more times it doubles, the more money you have at retirement or whenever you cash in your investment.
Using the Rule of 72. – The Rule of 72 helps you understand how a slightly better investment vastly increases the amount of money earned over time. Suppose a 25 year old made an investment at 8% with the intent of cashing it in at the age of 65. Using the Rule of 72 we know that an 8% investment will double in value every 9 years. That means that over the 30 year period, the investment will double 3.33 times.
If the same 25 year old made the same investment at 10% interest their investment will double every 7.2 years. over the 30 year period, the investment will double 4.16 times. By making only a slightly better investment, the money doubles faster resulting in thousands of additional dollars at the end of 30 years.
While the possibility of a high rate of return on your investment is exciting, the earlier you begin investing the less pressure you have to earn a higher rate of return. The more time is one your side, the more opportunities your money has to double.
There is no substitute for the time value of money. Retiring at 55 is a great idea, but it sounds better to someone who began saving at age 25 than it does to the person who waited until age 45.
Plan for your financial future. Start saving, start planning and start using the Rule of 72!
Rule of 72 – A Debt Management Tool
The Rule of 72 is fun to use when calculating how much money you can accumulate for retirement. It also calculates how fast your debts can double with high interest rates, such as those charged on most credit card accounts. While this isn’t as pleasant to think about as bulging bank accounts in your future, getting control of your debt today is the place to start.
While you want your savings and investments to double as many times as possible, you want your debts to double as few times as possible. Using the rule of 72, if you have a debt $7,000 at 18% interest, your debt will double every 4 years, assuming you did not make any payments. You say “But I do make monthly payments on my credit card!” The problem is that as much as 90% of a typical minimum monthly credit card payment goes toward interest. Paying interest does not pay down your debt. Unless you are paying significantly more than the minimum payment you won’t pay down the principal balance you owe.
Remember, money owed on credit cards that costs you interest is money not available to earn interest. That’s why the fastest way to earn an immediate 18% on your money is to pay off that credit card!