The rule of 72

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Overheard

“We say ‘no’ to almost everything” - Eddy Cue of Apple on their success.

A Suggestion

The Rule of 72.

One of the most basic, and misunderstood concepts, of money is how it grows, either for you or against you.

It’s hard to understand how powerful a 5% return on a $15m investment account is. Simply by owning the assets, and assuming you earned a 5% return, your net worth would grow $750,000.

That is a third of what most people make in their lifetime working 2000 hours per year.

It’s incredible.

The reason this is hard to conceptualize is because most of us, like 99.9%, will never witness how powerful returns are with large amounts of money.

According to Fidelity, the average balance on a retirement account for a 55 year old is $256,244. A 5% return on that money is $12,812. Yawn.

Enter the rule of 72, a simple and effective way to help understand the power of returns and the value of patience.

By dividing 72 by your interest rate, you can quickly determine the amount of time it takes to double your money.

Let’s take this example from Fidelity again, it would take the average 55 year old 14.4 years to double their money. Assuming the returns stay at 5% and there is no spending of the account, this person would have approximately $500,000 at 70.

You’re probably reading this and thinking wow, that isn’t a lot of money, I spend XXX amount per year.

And you would be correct. On one hand, $500,000 is a lot of money, but on the other hand, if you earn $120,000 a year and spend $85,000, this is not adequate to support your future self.

But where the magic lies is when you give yourself time to let your assets compound.

If you leave that original investment of $250k go for 35 years at 5%, you’d get $1.379m. Not bad.

The Rule of 72 gives you a fast, and effective way, to do math in your head and help you make financial decisions better.

Let’s see this in action.

You and your spouse are at a car lot and there are two cars in front of you, with a $15,000 difference in price. You know the rule of 72.

You lean over to your spouse and say, “honey, we can turn that money into $60,000 in 14 years if the stock market returns the average of 10%, and $215,000 if we let the money grow for the rest of our career, not including what we are saving now. Let’s go for the cheaper vehicle.”

And just like that, the rule of 72 does it’s magic by helping frame a financial decision properly.

Don’t use the rule of 72 sparingly, use it often, with confidence.

Hope this helps friends.

See you next week.

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