Tuesday, December 23, 2008

The Rule of 72 is Cool!

When people invest money, they do it so they can make money. That’s called "getting a return on your investment.” Sometimes they want to know how long it will take to double their investment. To do this, we use the Rule of 72.

Take 72 and divide it by the amount of return on your investment. That is the number of years it will take to double your original investment.

For example: Ten year-old Keanu buys a bond for $10,000 and earns 6%. 72 divided by 6 = 12. So every 12 years, Keanu’s money doubles. When he is 22, he will have $20,000.

What if Keanu leaves that money alone until he retires at 60 years old? His money will double 4 times by then and he will have $160,000.

Let’s say Keanu used that original $10,000 and bought a stock that earns 12% return (72 divided by 12 = 6) he will have $20,000 in 6 years when he is 16. If he leaves that money alone until he retires, it will double 8 times and he will have over $2.5 million when he is 60 years old.

The Rule of 72 is based on a principle called “compound interest” (return), which is sometimes called “The 8th Wonder of the World”! I’ll explain more about compound return in my next post.

Here’s something VERY important to remember. Just because things happened in the past, doesn’t guarantee they’ll happen in the future. So we use historical return rates as an example. It doesn’t mean that if you invest in the stock market today, that you will receive 12% return on your investment every year. Also, when investing in stocks it is possible to lose money, so that the value of the stock could be less than the original investment.