For those of you who don’t know, I am an undeniably proud math nerd. Obviously, this has its pros (understanding money, finance, statistics, etc.) and its cons (math jokes aren’t such a big hit in most social circles). Luckily, it’s enabled me to do some financial translating for you, and so today I bring to you the rule of 72.
A couple of weeks back I posted an entry about the wonder that is compound interest, Financial Advice From Einstein. The rule of 72, which Einstein discovered and relates directly to the idea of compound interest. When you invest in any account that gives you compound interest, all you need to do is divide 72 by the interest rate you are receiving and it gives you an estimate of how long you can expect to wait for your money to double.
For example, let’s say you have $1000 invested in any account. Imagine you are receiving a 6% interest rate (rate of return) on the account. According to the rule of 72, all you need to do is divide 72 by 6 to figure out about how long it will take your $1000 to turn into $2000.
72 ÷ 6 = 12
So, assuming you just let your money sit in your savings account and never add to it, it will take about 12 years for your $1000 to turn into $2000.
You can start to get a sense of how important rate of return is when you compare interest rates of 1, 4 and 8 percent using this rule:
72 ÷ 1 = 72 years to double
72 ÷ 4 = 18 years to double
72 ÷ 8 = 9 years to double
Money invested in the account that has an 8% return only takes 9 years to double, while money invested in the 1% account takes a whopping 72 years! That should make you think twice about leaving your money in a savings account with an interest rate of 1% or less. Counter-intuitively, the account making a 4 percent return won’t be halfway between 9 and 72. However, it is important to note that a 4% return will take twice as long to double as an 8% return.
You can, and should, also use this rule to keep track of your debt. If you have $1000 in credit card debt, and the interest rate is 10% on your credit card, it will take just over 7 years for your $1000 debt to turn into $2000 in debt. This rule is especially handy these days, when credit card interest rates can run in excess of 20%.
Granted, the rule of 72 isn’t an exact science, but it is known and used by financial gurus everywhere as an estimation tool. Even if you aren’t a self proclaimed math nerd like me, whip out your calculator and start dividing! You might be surprised to find out how little, or much, your investments are making.