Rule of 72 – The Power of Compound Interest

On December 6th, 2013, posted in: Economic News, LIfestyle Planning by

Albert Einstein and Benjamin Franklin identified compound interest as a wonder of the world, perhaps the 8th wonder. Learning how compound interest works and mastering it are fundamental to growing your wealth. Learn these principles and you can control your financial destiny.

Let’s start with the basics. Assume you could earn a constant 6% every year. If you invested $1, it would grow to $2 in 12 years. Do the math and you will see this is true. What is interesting is that in 12 more years your $2 will now be worth $4. This doubling is called the rule of 72. The rule says, “if you divide the interest rate into 72, quotient will be the number of years it takes money to double.”  So try it.

Rule of 72 - 1

As you can see from the table, the higher the interest rate, the fewer years it takes for money to DOUBLE. So how many intervals do you have until you reach retirement? The goal is to grow your money so you have enough to live on when you are no longer able to work. If you are 40 years old, and you can earn 6% on your money, you have about 2 intervals until you reach 65. So if you have $100,000 in your 401k, it will be worth $400,000 ($100,000 grows to $200,000 and then doubles to $400,000) in 24 years. If you wait until you are 72 to start taking the money, you will be part way (2/3rds) through the 3rd interval.  So your $400,000 would grow by about $260,000 to $666,000. Here is a table to show the number of intervals you have until age 72 (the new retirement date for most people).

Rule of 72 - 2

Look at the chart carefully. At 6%, you had 2.67 intervals before you reach age 72 if you start at age 40 (1st interval is age 40 to age 52. The 2nd interval is age 52 to age 64. And then part of the third interval – 8 years to age 72). Your $100,000 would have grown to $666,000. But what if you could earn 10%? Then you would have 4.44 intervals and your $100,000 would double 4 times. (Age 40 to age 47.2; age 47.2 to age 54.4; age 54.4 to age 61.6; age 61.6 to age 68.8 and then 3.2 years to age 72). That’s FOUR DOUBLES plus a little. Your $100,000 would grow to nearly $2,400,000 over that period of time.

So ask yourself – what is the POWER of compound interest? The POWER is time. The longer you let money work, the more it will grow to over time.

Does it make any sense to procrastinate? Does it makes sense not to contribute to your 401k as much as you can as fast as you can? Sure, it will take some self-disciple and personal sacrifice. But it is worth it. Get as much into your 401k as you can, as fast as you can. Then the Rule of 72 will work for you!!!

 

This information is compiled by Guy Baker from an assortment of news feeds including First Trust, Yahoo Finance, Bloomburg and others. This information is intended to be informational only. This newsletter contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Investing involves risk including the potential for loss of principal. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.

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