A Tool So Simple Your Kids Can Use It
INVESTING MADE EASY WITH RULE OF 72
A Tool So Simple Your Kids Can Use It
Investing can get complicated.
Which way are prices heading? Will rents continue to rise? Will the stock market crash again? Is my money safe? Can I retire yet? Or when can I retire if I keep investing as I am now?
But it doesn’t have to be complicated. Here’s a tool even kids can use if they know how to multiply and divide.
A CAMPFIRE CONVERSATION
Recently my wife and I were sitting around a campfire with other real estate investors. Some of them had their kids there as well. Someone asked the kids how much financial education they received in school. The answer was not much.
One kid told how a teacher tried to explain what an asset was. The teacher said a car was an asset.
The kid tried to explain that an asset puts money in your pocket, but a car costs you money.
Everyone agreed the financial education in schools is minimal. And it tends to be oriented toward operating a business, not personal finance.
Then someone asked who knows the Rule of 72.
Most of the adults raised their hands. But only a few of the kids raised theirs.
So what is the Rule of 72?
RULE OF 72
The Rule of 72 is a simple tool that can be used to determine how long it will take an investment to double in value. It’s not exact, but it is pretty close.
Let’s look at a few examples to see how it can be used.
ONE. HOW LONG IT TAKES AN INVESTMENT TO DOUBLE
Suppose you take some money and put it into a certificate of deposit, or CD, that pays 4-percent interest. Using the Rule of 72, how long will it take to double your money?
Divide 4 into 72, and you get 18. So you can double your money in 18 years if you invest in CDs paying 4-percent interest.
Suppose you found a different investment that earns 8-percent per year. Divide 72 by 8 and you get 9. So we expect that it will double in value in 9 years.
Nine years sounds better than eighteen.
What if we can find an investment earning 12-percent? How long would that take to double your investment?
Did you get 6 years?
TWO. WHAT IS THE EFFECT OF CARRYING LOAN BALANCES?
What would be the effect of carrying a credit card balance and only making minimum payments? Let’s use the Rule of 72 to determine how long it will take for that loan balance to double.
Let’s just assume that the interest rate is 18-percent and the minimum payment is negligible.
How long will it take for the loan balance to double?
Divide 72 by the interest rate. What do you get?
It would only take 4 years for your loan balance to double. OUCH!
What happens if the interest rate goes up to 24-percent?
The balance would double in only 3 years.
That is easy math, using the Rule of 72, that kids need to understand BEFORE they apply for a credit card and carry a balance rather than pay it off each month.
THREE. WHAT IS THE EFFECT OF INFLATION?
How much do you expect prices to go up in the future?
The inflation surge from 2021 through 2023 has shown that inflation is not constant. But we do know that we are paying more for gas, groceries and housing than we did ten years ago. The average inflation rate from 1960 to 2022 was 3.8 percent. So for simplicity, let’s use 4-percent as an estimate of future inflation and apply the Rule of 72.
We need to know this because in the future we want to be able to live off of our investments.
So if we assume inflation to be 4-percent, how long do we expect it to take for prices to double?
This number sounds familiar. 72 divided by 4 is 18. So we expect prices to double in 18 years. Will you be ready if prices double in the next 18 years?
Another way to see this is how large your portfolio needs to be. If $1,000,000 is enough today, then in 18 years it will take a $2,000,000 portfolio to provide the same standard of living. Please multiply these numbers as needed for your desired lifestyle.
Investing doesn’t have to be complicated. Some aspects are simple to understand. If you have kids, do they know about the Rule of 72? Do you?
HELP US GET TO KNOW YOU BETTER
Do you have any simple investing tools that you are willing to share?
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Mike is a retired aerospace engineer with a passion for real estate investing and teaching financial literacy. He lives with his wife in Daytona Beach, Florida.