When Will I Double My Money?
In this week’s Money 101 post, the Nuru Personal Finance deck brings us the Rule of 72:
Definition
The Rule of 72 is a quick way to determine how long it will take you to double your money at a given interest rate.
To Calculate
Divide the number 72 by the annual interest rate you expect to get on an investment. The answer represents how many years it will take to double your money at that interest rate.
72 / interest rate = years to double
Application
Suppose you invest in an account that promises an interest rate of 6% compound annually.
72 / 6% (interest rate) = 12 (years)
It will take about 12 years for you to double your money at 6% interest.
Application – Part II
Now let’s alter the situation a bit. Say you want to double your money in 3 years, but you don’t know what interest rate you need in order to do so. You can use the same equation, this time dividing 72 by the number of years you’re willing to invest.
72 / 3 (years) = 24 (interest rate)
In this case, you will need to earn an interest rate of 24% to double your money in 3 years.
Double Your Money
Remember, if you want to achieve financial freedom, you need to be consistently doubling the money you’ve earned. The Rule of 72 shows you what it will take to get there.
I think it goes without saying, but this concept assumes all things remain constant – consistent growth and no additional contributions. Given our current economy, it’s probably easier to estimate how quickly you can lose half of your money. :-(
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Ok, the awesome return of 24% for three years doubles my money. How easy is it to go back to the beginning? Well, if my 100 grow to 200 in three years since I invested so wisely (or since I was just plain old lucky) and then my investments tank by 50% like the stock market has done, I am back to 100 which makes for a 0% return in 4 years. That scenario is calculated with a loss that is just a touch higher in percentages than the profit of two years. So, profits get erased a lot quicker than they get built up.
Yeah, I feel like at this point, it’s going to take me 72 years to double my money, if I”m lucky!
Your last point was a good one, SM.
I’m also thinking maybe all those financial companies like Fidelity and American Century with time value calculators on their retirement websites should probably just pull the calculators offline for a while.
Wishful thinking won’t help anyone.
You bring up a good point though…it’s amazing how many people I talk to that do not have any idea about the whole “high risk=high reward” concept!
Plain Scared, I bet a lot of people just plug #s into the calculators without thinking about the increased risk of the assets that offer fast doubling, just how long it takes to double their money.
That’s a handy calculation of which I’d never heard. Really lets you know where you stand with a “high interest” savings earning a 2.75% or whatever the current rate is!
Mary, the current “high interest” CD rates being offered by banks like B of A may not be eye-popping compared to “growth” stocks but they also have far, far less risk because they come with a guaranteed payoff at a guaranteed date and they are insured.
Every investment’s return must be evaluated relative to its risk and inflation. In a credit crunch like we have right now, we would expect banks to actually offer good rates relative to these factors. That is because, in a credit crunch, banks must compete for consumer deposits to boost their finances, so they are offering more for CDs than they would under non-credit-crunch circumstances.
That’s a great rule to keep in the back of your mind. If anything it reaffirms the importance of continually adding to your savings, because at 2.75% it would take my entire lifetime to double my money.