Thursday, March 1, 2018

The Rule of 72: Applications for Investors


To quickly estimate how long it will take for a sum of money to double, divide 72 by the expected interest rate that can be earned on a savings or investment product. For example, $2,000 placed in an IRA invested in a stock mutual fund would grow to $4,000 in nine years at an 8% average annual return (72 divided by 8). The Rule of 72 assumes that the interest rate stays the same for the life of an investment and that all earnings are reinvested.

Let’s look at how $2,000 could grow over an investor’s lifetime. If a $2,000 investment is made at age 22 and earns an average 8% return, an investor would have the following amounts:

  • $4,000 at age 31 (nine years later)
  • $8,000 at age 40 (nine more years)
  • $16,000 at age 49 (nine more years)
  • $32,000 at age 58 (nine more years)
  • $64,000 at age 67 (nine more years)
     
    Note that age 67 is currently the full retirement age (FRA) for persons born in 1960 or later to receive an unreduced Social Security benefit. It is, thus, a target retirement age for many young adults.
    If a $2,000 investment is made at age 31, instead of age 22, and earns an average 8% return, an investor would have the following amounts:
  • $4,000 at age 40 (nine years later)
  • $8,000 at age 49 (nine more years)
  • $16,000 at age 58 (nine more years)
  • $32,000 at age 67 (nine more years)
     
    Note that the late starter’s savings is just half of the first investor’s amount. The second investor lost the last doubling period, where the real payoff occurs, by waiting an extra decade to start investing. In other words, procrastination is very costly. Compound interest is very much like the final questions on the initial Who Wants to be a Millionnaire? game show format, where large dollar amounts get doubled on the final questions. Learn more with this online calculator.

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