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Investing - What's the Rule of 72?
Have you ever wondered how much some of your investments will be worth 10 years from now? How about 20 years? You can easily figure it out without using a financial calculator. Just use the Rule of 72.
Let's say you invested $10,000 in a fixed annuity earning 6% a year. In 24 years, your assets will be worth about $40,000. How does it work?
The Rule of 72: Divide the number 72 by the interest you earn, and it will give you the number of years it will take for your money to double. Using the above example, 72 divided by 6 equals 12 years for doubling. Since there are two doubling periods in 24 years, the original $10,000 would be worth $20,000 in 12 years, and $40,000 in 24 years.
Using this same Rule, an investment earning 8% would double in about 9 years, and a 12% investment would double in 6 years.
You need to remember that a 6% interest rate in a Certificate of Deposit would not work as well as a 6% annuity. A CD earning 6% would leave an investor approximately 4% after taxes. The Rule of 72 would only apply to an after-tax yield. A 6% annuity would be tax-deferred; therefore, the entire 6% would be counted.
The Rule of 72 works best with fixed investments, or those with a fairly stable return. Also, it only works if you reinvest your assets. The Rule does not apply if you withdraw any funds.
You can even use this Rule in reverse. For example, you are 38 years old, and you'd like to know how much you'd have to invest today to retire a millionaire.
Using the same Rule (assuming a retirement age of 65, and an average annual return of 8%), here is how it would work:
Step One: 72 divided by 8% would signify that your money would double every 9 years.
Step 2: At age 65, you want your assets to be worth $1,000,000, so...
Step 3: You work in reverse, going back 9 years for every doubling period.
$1,000,000 at age 65 (your goal)
$500,000 at age 56 (9 years earlier)
$250,000 at age 47,
$125,000 at age 38 (lump sum)
If you invest $125,000 at 8% until age 65 (before taxes), you would have about $1,000,000 at retirement. This amount would change, of course, if you invested more than $125,000, or if the interest were higher, or better still, you started investing a little sooner than age 38.
Depending on your goals, and your age, you could retire earlier or later than age 65. You don't have to invest a lump sum to retire comfortably. Just have a goal, and a systematic investment plan, and your retirement needs will be accomplished.
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