August 29, 2013

The rule of 72 demonstrates how compound interest creates wealth. What is the rule of 72?

4 thoughts on “August 29, 2013”

  1. Katherine Graham says:

    The rule of 72 deals with the average return you are earning and how many years it will take you to double your money through compound interest. Example: You are earning 4% in a CD. You take 72/4 and that will get you the amount of years that it will take you to double your money. In this case, the answer is 18 years.

  2. Mike Finley says:

    Well said, Katherine. Let’s take a look at an example. Let’s take a $10,000 initial amount. You take that money and invest it in two no-load index mutual funds (no commissions and very low yearly fees). You select a total stock market index fund and a total bond market index fund. You decide an 80/20 allocation is right for you. That means 80% will go into the stock index fund ($8,000) and 20% will go into the bond index fund ($2,000).

    Now, let’s project a 9% AFTER cost return on your money (slightly below the 9.4% historical return based on this asset allocation). Here is how it plays out. 72 divided by 9 is 8. Your money will double every 8 years.

    In 8 years, $10,000 turns into $20,000. in 16 years, $20,000 turns into $40,000. In 24 years, $40,000 turns into $80,000. In 32 years, $80,000 turns into $160,000. Finally, in 40 years, $160,000 turns into $320,000. Compound interest made this happen with that initial investment of $10,000 (no other money was added).

    Moral of the story? Get started NOW investing in those boring, cheap and efficient no-load index funds at a place like Vanguard. Time is your friend and compound interest will bring you wealth gradually over time. Get started NOW!

  3. Janet Kuper says:

    The rule of 72 helps you to find the number of years it will take you to double your money at a given interest rate. You have to divide the compound return into 72, with the result being the number of years, approximately. I used this when I was looking at investment for my retirement.

  4. Mike Finley says:

    Exactly, Janet. Welcome to our board. Chime in any time. All comments are welcome as we reach for that elusive thing called financial happine$$.

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