How Healthy Are Your Finances Series- Part 7
Ever hear of the Rule of 72? It is a great financial rule of thumb that calculates how many years it takes to double your money using compounding return rates. When you are saving for your different financial goals, understanding compounding interest and the rule of 72 will help you as you navigate through different investment options.
So what exactly is the rule of 72 and how does it apply to compounding interest? According to Investopedia, the rule of 72 is defined as, “A rule stating that in order to find the number of years required to double your money at a given interest rate, you divide the compound return into 72. The result is the approximate number of years that it will take for your investment to double.”
For example, if you have $10,000 and want to know how long it will take to double your money at a 2% compound interest, divide 2 into 72 and you get 36 years. If you take the same $10,000 and instead use an 8% compound interest, it will take 9 years to double your money– 72/8=9. Get the picture?
This becomes important as you save for your financial goals because you want your money to be working hard for you. If you are 35 years old and your financial goal is to accumulate 1 million dollars for retirement by age 60, it does not mean you have to save 1 million. It means your money has to GROW to 1 million– big difference. The more time you have to grow your money, the less money you need, because compounding interest will be hard at work for you.
Let’s look at it another way. Say after analyzing your spending plan, you noticed you were spending $40 per week going out with your girlfriends for dinner. If you instead decided to eat at home, save that $40 per week, and invested it at an 8 % annual compound interest, after 20 years you would have accumulated $95,184!* Compounding interest at its finest… now can you see why many people consider it to be the 8th wonder of the world?
*$40 per week, 52 weeks, compounded at 8% for 20 years
Even if you only have $50 to save per month, by starting now, you will have more time to allow compounding interest to work in your favor.
Here is another example of how compounding interest works:
*The rule of 72 is a mathematical concept and does not guarantee investment results nor functions as a predictor of how an investment will perform. It is an approximation of the impact of a targeted rate of return. Investments are subject to fluctuating returns and there is no assurance that any investment will double in value.
Financially Wise Women Quick Tip:
Remember it’s never too early or too late to start investing and no amount is too small. The key is to invest your money according to your goals and invest regularly and automatically. For further information I invite you to check out my Financially Wise Women Ebook or contact me directly at Brittney.castro@Lpl.com
You work incredibly hard. Don’t forget to protect yourself. Read more in Part 8.