Previously I went over briefly the Rule of 72. After going the rule over with a few people in the last couple of weeks it seems the power of the tool is lost until it is applied in a personal finance context. The math behind the rule is simple. The number of 72 is divided by the interest rate of an investment equals the time in years the money will double.
The Dollar Seed
One way to see the power of one dollar is to see how much it could be worth at retirement. Let’s suppose you are 21 years old and you have a dollar. You have a choice of what to do with it. (Give it away, Spend, Save, or Invest) You choose to invest it and decide to put it in an index mutual fund that averages about 10% ROI per year. This dollar is put into a retirement fund.
The Doubling Cycle
The retirement age you are shooting for may be 71 years of age. With the above investment using the Rule of 72 formula (72/10 = 7.2 years) , the cycle to double is 7.2 years. The chart below shows a little about the dollar over time. By the time of retirement the dollar is worth $128.
This doesn’t seem like a big deal but, what if instead of one dollar you put $1000 in the fund initially? What would the end result be?
The increase is something that gives people some notice. $128,000 is not bad for a $1000 investment. What if instead we were to put the limit for a 401k instead?
In 2017 as I write this the limit is $18K so the output at retirement is $2.3 Million. The long term thinking along with compounding interest becomes something powerful. Of course this is a rough way to look at predicting what you can approximately have at a particular time.
The Rule of 72 tool only took into account a one time money drop. Most people can’t put up the IRS limit for retirement and put a portion monthly and for more than one time. Also if you have a company match that is additional money.
Let’s suppose you are 14 years old and were able to save $5,000 babysitting and put that money in the above index fund?
By the time the 14 year old reaches 21 the money is now $10K; enough to buy a decent car. Or by 28 years old $20K; enough to put a down payment on a modest house. If the money was collected at 50 years old the $160K may be enough to buy a small rental or vacation property. The power of starting young and having foresight can make all the financial difference in the world.