To maximize your nest egg, it’s important to understand how compound interest and the rule of 72 affect your investments.
The rule of 72 is a mathematical formula that calculates approximately how long it takes your money to double, by dividing the interest rate you’re earning into the number 72. The answer is the number of years it takes for your money to double.
For instance, if you were able to earn an average 6 percent average annual rate of return on an investment, divide 72 by 6 and you would get 12. This is the number of years it would take for your money to double. That means that in 36 years, your money would double three times. First, $1,000 doubles to $2,000, then $2,000 doubles to $4,000 and finally $4,000 doubles to $8,000.
If you think that’s a lot, imagine if I could make 12 percent for those 36 years. This means the money would now double every 6 years (72 divided by 12). If you work through the numbers you will see that the total in 36 years is now $64,000, instead of $8,000. Wow! Doubling the interest in this example would mean making eight times the money. If you have some time on your hands, you could work through the example using 18 percent return. (The money would double every 4 years.) Just make sure to be sitting down when you do.
As you can see, the difference of a few percentage points over a lifetime can result in thousands of dollars of additional money for your nest egg.
Lastly, here’s one of my favorite examples of compounding. Let’s say you’ve been hired to complete a task for someone that will take 30 days. He tells you to choose which way you would like to be paid for your month’s work. You can choose to receive either $1 million in a lump sum or one-cent on day one and have it doubled every day for 30 days. Which would you choose?
Well, since I’m writing about compounding, you probably guessed that one-cent doubled daily is the correct answer. By the way, that works out to over $5,300,000. The bottom line to all of this is, know the rates of return that your investments are earning and fight for every percentage point.
Tags: investment advice, financial advisor, retirement planning, financial advice, personal finance, rule of 72, compound interest