The Formula that Doubles Your Money – Property Formula

It’s every investor’s dream come true: the benefit of hindsight. While we may not have a crystal ball, there is a simple tool which can help us figure out how much good or harm a specific decision would bring before it’s even made.

It’s an easy piece of maths magic called the ?Rule of 72?, and if mental arithmetic is not your strong point, you can work it out on a pocket calculator in about 10 seconds.

The Rule of 72 is a handy rule of thumb that estimates how long it will take for an investment to double in value. In other words, divide an investment’s annual return into 72, and you will get a rough idea of the number of years necessary to double your money.

We’ll show you how it works. Let’s assume that safety-conscious Sally has invested $10,000 in a fixed deposit at 5% per year compound interest. If you divide 72 by five (your annual income at 5%) you get a result of 14.4 years to double the investment.

The really scary thing is that the Rule of 72 works the other way too – it tells us how long it would take for our debts to double. If you owe $10,000 on your credit card at 10% interest and you don’t pay it off, your debt will double in around 7.2 years and you will owe $20,000.

There are two things you can learn from the Rule of 72 that could help make you richer or poorer. The first is that time is money. The second is that discipline is everything.

The price of procrastination

The Rule of 72 tells us that the longer we wait to start an investment program, the more money we will need to save over a shorter period of time in order to reach our financial goals.

You can prove that by comparing the fortunes of two imaginary investors. The first, 21-year-old ambitious Angus, saves $2,000 a year every year until he turns 30, then stops. The second, late-starter Larry, begins at 31 years of age, but saves $2,000 a year until he turns 65. This table shows us the outcome of these two investment plans.

Angus Larry
Age 21 3
Investment $2,000 p.a. over 10 years
Then nothing to age 65
$2,000 p.a. to age 65 (34 years total savings)
Interest rate 8% p.a. compounded 8% p.a. compounded
Amount at age 65 $428, 378 $344, 634

So Angus has put aside $20,000 over 10 years and won’t touch it for another 35 years, while Larry has put aside $68,000 over 34 years. Who is better off at age 65?

Assuming that they both chose the same account, earning 8% per annum compounded, young Angus? $20,000 would be worth $428,378 at age 65. By contrast, the $68,000 saved by Larry would only be worth $344,634 – a whopping $83,744 less.

Here’s the sad truth. Although Larry has saved much more diligently for a longer period, Angus, with much less capital but an extra 10 years on his side, beats him by a substantial amount.

The lesson is simple: it pays to start early, because the earlier you start the more you can tap into the power of compound interest. Procrastination comes with a hefty price tag.

“Well begun is half done.”
Aristotle

Time is money

If you look at real life, the Rule of 72 is a very handy tool to use to put things into perspective.

Let’s say you were a 20-year-old with $10,000 at your disposal – an inheritance from your great uncle Archibald perhaps. You can spend it. Or you can invest it in a savings account, a managed fund or whatever. If you apply the Rule of 72 you can estimate that placing the money in a managed fund that has historically produced an average return of 10%, will mean that you’ll potentially double it in 7.2 years.

Being 20, you may decide that your windfall is there to be spent on a new set of wheels, but at the very least, applying the Rule of 72 forces you to think about the long term.

And if you look even further into the future, and assume you can invest that same $10,000 at an average of 10% after tax at age 20, you’ll turn it into $174,000 by age 50. But that depends on having the discipline to invest it and not spend it. The Rule of 72 encourages us to invest money early and leave it alone.

You can also use the Rule of 72 to make more informed judgments about potential investment options that are offered to you. By having a realistic idea of how long an investment would take to double, you could decide whether it would generate a realistic return, and compare it to other types of investments – property or fixed interest versus a managed fund, for example.

You must remember, though, that no formula can replace plain common sense. No matter what the Rule of 72 tells us, if an investment sounds too good to be true, then it more than likely carries an unmanageable amount of risk.

“Experience is a good teacher, but she sends in terrific bills.”
Minna Antrim

Discipline is everything

The Rule of 72 encourages us to behave with the long term in mind, and teaches us a valuable lesson about how our thoughts and behaviours contribute to the outcome of our financial future.

It tells us that starting to save earlier and investing spare cash for longer can be much more rewarding than spending it on fleeting pleasures. But that’s not all. As we have mentioned, the Rule of 72 works for your debts as well as your investments.

The more you borrow and the less you pay on your debt, the more the Rule of 72 works against you. Most times, the Rule of 72 encourages you to borrow as little as possible at as low a rate as possible and to pay back as much as possible, as soon as possible. But what happens if you decide to borrow money in order to invest it? In other words, make a geared investment.

Here you can use the Rule of 72 both ways – to calculate the real scope of the debt and to calculate the potential profit of the geared investment. Obviously, if the profit potential did not outweigh the cost of borrowing, you would not go ahead.

The other important thing to remember is that it is never too late to start. Even if you are 40 years old and haven’t saved a bean, you still have a golden opportunity to plan for some financial security by the time you are 65, and whatever you end up with, it will be a lot more than if you simply did nothing.

The more you are aware of the Rule of 72, the harder it is to justify letting money slip through your fingers. The rest is up to you.

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