What is the rule of 72 and why should you care?
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. You should care, because it demonstrates how compound interest creates wealth. This will help us escape the world of work one day!
You should care about the rule of 72 because it will show you the importance of taking on reasonable risk with your investment for the most growth. The rule is this: take 72 and divide it by the average return on your investment and that will be the number of years it will take to double your money.
The rule of 72 lets you know how long it will take for your money to double. Lets say you have your money in the bank at .5% it would take you over 144 years for your money to double in the bank. While if you had your money at Vanguard in the Total stock market index making on average 10% a year it would only take 7.2 years for your money to double and actually would let you see your money double in your life time. So this is why you should care. You need to know how much money you will have when you plan on using it, if you are planing on retiring from money growing in the bank you better be a vampire. This is the return even before we take in inflation so the money in the bank would really be losing ground over this time.
Clearly, you three understand this idea quite well. I agree with Garrett, unless you are a vampire, and I hope you aren’t, expecting your money to compound in the bank to any meaningful amount in your lifetime is a fool’s errand.
Learn about risk and reward. With one, comes the other. The key is to mitigate your risk as best you can, and take the appropriate amounts as you reach for higher rewards (return on investment). This can be done with no-load index mutual funds at Vanguard that own stocks, bonds, and REITS. Compound interest will do the rest as you make time your friend. Believe it!
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