Use the Rule of 72 to Simplify Your Financial Decisions
Today on The BIGG Success Show, we brought back one of our favorite bits – Terms from a Hat. This time we pulled out…The Rule of 72.
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The Rule of 72 is a quick way to determine how many years it takes to double your money. You simply divide the interest rate into 72 to get the number of years it will take to double your money. For example:
Let’s say you have an investment that earns 6%. 72 divided by 6% = 12 years. You’ll double your money in 12 years.
See how easy that is!
Calculating the long-term potential of a bonus
So let’s say you get a bonus this year of $5,000 (after taxes). You decide to invest it for your retirement in 24 years.
This one-time investment of $5,000 could be expected to turn into $10,000 in 12 years which will turn into $20,000 by the time you retire in 24 years.
A caveat and the implicit assumptions
One caveat though – it’s not absolute. It’s a rule of thumb. In a pure mathematical sense, it’s technically 69.3, not 72.
If you want a deeper dive, check out the technicalities of The Rule of 72.
Besides the caveat, this rule also makes some simplifying assumptions. It assumes that all investment income is tax deferred or tax free. Further, it assumes that your return occurs certainly and evenly over the life of the investment.
Since most investments don’t work this way, Charles Givens suggested in Wealth Without Risk that that you should use 76 instead of 72.
However, we suggest that you not get hung up on the number. Just remember it’s an approximation. More importantly, it’s a tool.
So let’s talk about how to use this tool to quickly see the impact of financial decisions.
Using the Rule of 72 to choose a car
Let’s say you need a different car. You find two cars you like and you have the cash to buy either one.
However, one car costs $5,000 more than the other one. We’ll bring back our previous example – where you thought you could earn 6% on your money and assuming you want to retire in 24 years.
By buying the cheaper vehicle, you will have $20,000 more at retirement. So is it worth spending an extra $5,000 on a car now to give up $20,000 later?
Seeing the difference between investment options
Let’s go back to the bonus of $5,000 after-taxes. You won’t need the money for 24 years, when you plan to retire.
You have a choice of two investments – one that has yielded 3% historically and another one that has returned 6%.
With the first investment, you’ll double your money one time in 24 years – ending up with $10,000. With the second, you’ll double it two times – so you could expect it to turn into $20,000.
Why your own business may be the answer
Finally, let’s talk about owning your own business. A lot of people have seen their investment portfolios hit pretty hard.
If you’re one of them, what can you do? Invest in your own business.
It’s not unrealistic to think you can earn 12% on your money. Then you would double your money every six years.
So that $5,000 becomes $10,000 in six years, $20,000 in twelve, $40,000 in eighteen and $80,000 in 24 years.
This is how real wealth is created. Look at any list of rich people – they probably own their own business.
Of course, remember that this is general advice. You’ll want to seek the advice of your professional advisors about your situation.
The Rule of 72 helps you make investment decisions by helping you quickly understand how money compounds. It’s a financial tool that will help you reach BIGG success!
Direct link to The Bigg Success Show audio file | podcast:
http://traffic.libsyn.com/biggsuccess/00838-112912.mp3
