The rule of 72 is a rule that can answer you the question: How many years will my money need to double for a given interest rate?
It closes the gap between an interest rate and what it means in real life.
Here is the rule of 72:
t = 72 / Interest Rate in percent
So how long would your money need to double with an interest rate of 7%? (Average historical inflation-adjusted stock market return)
72 / 7 = 10 years
Or quadruple it within 20 years. That’s what’s in for you. That’s why, even 10 or 15% of your disposable income saved can make a huge difference over time.
That is the only reason early retirement is possible.You just have to save a lot of money and let it sit.
You just have to save a lot of money and let it sit. Or save only a few bucks and let them sit even little longer.
Compounding can also work against you.
Say you have a credit card and it charges a 15% interest rate. How fast will the amount you owe be doubled?
72 / 15 = 5 years
This is insanity as you see. Even if you are required to pay off some of the principal every month.
Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.
So every time you hear an interest rate I want you to apply the rule. It will translate it into something a little more meaningful for you.
Use it to help you with financial decisions. Choose wisely.
Image Credit: photo by Images_of_Money (_Flickr) shared under a Creative Commons (BY) license_