I was discussing with a younger client recently the importance of compound interest and it brought me back to a quick hack I was taught when I first started advising and didn't really have a clue what I was doing. My Mentor told me about the rule of 72 and it has stuck ever since. So what is the rule of 72 and how long does it take to double an investment?
Of course the answer to the above is that it depends what you are investing in and how it performs. From a planning perspective however it is very useful to know how long it will take you to reach your financial goals at different levels of performance because investments are predictably unpredictable.
The Rule of 72 is a simple mathematical equation that can estimate the number of years required to double the invested money at a given annual rate of return.
Years to Double Money = 72 ÷ Rate of Return
Therefore if you get a 10% growth rate compounding it is going to take roughly 7.2 years and if you get 7.2% growth rate it is going to take roughly 10 years. Go on, try it... put it into a calculator, it is fairly accurate.
So why is this important from a planning perspective? Well, this helps you work out that you should start saving as much as you can afford to as early in life as possible.
If you invest and receive 7.2% return compounding each and every year then your investment is doubling over a decade.
Imagine this: You invest £50,000 at age 25 and receive 7.2% per annum compounding:
Age 35 = £100,000
Age 45 = £200,000
Age 55 = £400,000
Age 65 = £800,000
Obviously very few 25 year olds have £50,000 to invest but it really does show how costly delay and procrastination can be. Just a ten year delay means that you will have half the amount saved by age 65 at 7.2%. The Rule of 72 primarily works with rates of return that fall in the range of 6% and 10% very well. If you are working with integers outside of this range, then you can tweak the formula by adding or subtracting 1 from 72 for every 3 points the interest rate diverges from 8%. For example, the rate of 14% annual compounding interest is 6 percentage points higher than 8% - In this instance you would therefore make it the rule of 74 and for a 5% return you would make it the rule of 71.
This is all great but what can I do to improve my finances?
Simply call a local independent financial adviser - most will happily have an informal chat with you and help guide you to useful resources and, importantly from your perspective, identify if there is a need for advice. You should not pay an independent financial adviser for a chat or a first meeting and the great news is that we have to be qualified to offer advice and most advisers are very good at their jobs!
If you don't know much about the advice process then we have created a 6-step guide here.