Wednesday, March 13, 2013

Doubling your money and the Rule of 72

As greedy humans, we want something that doubles our money.

Fine, I will give you something that can double your money.

The Rule of 72.
(click or open image in new tab to enlarge)

How does this work?

You want to know how long will your money take to double in its nominal value. (How long will my P100,000 be P200,000?)

Of course, it won't double if you don't add or don't put it in a vehicle that earns interest.

For the rule of 72, assume that you will not add principal to the initial principal.

Take 72 and divide it by the annual interest rate and the quotient (answer) will be the approximate number of years it will take for the initial principal to double.

72/int. rate = [approx.] # yrs (2X money)

In the picture above (taken from the IMG's flip charts), at 4% interest, money will double every 18 yrs.

At 8%, every 9 years.  And at 12%, every 6 years.

From age 29 to 65, the number of years was 36 years. The huge difference between P400,000 and P6.4M comes not from the investment years but from the compounding interest rates.

What is the interest rate of your savings account? 1%?

72 divided by 1% equals 72 years.

Your P100,000 in the bank will take approximately 72 years to become P200,000.

Now, where can you find the 8% and 12%? They are not scams. Invest in your financial literacy. The options are there out in the open. Mutual fund, stocks, UITF...

Debt = Death

We can also use the Rule of 72 not just for investment purposes, but for debts and inflation.

If your credit card charges you 3.5% MONTHLY interest rate on your debt, then by doing the rule of 72 and assuming the debt principal remains the same, the total debt amount will double in about 20 months.

72/3.5% = 20.57 MONTHS

If the interest rate is in monthly form, then the answer is also in months. If the interest rate is yearly, then the answer is in years.

For inflation example:
If your annual expense is P120,000, and the inflation is at 4%, then after 18 years your annual expense will already be P240,000.

72/4% = 18 years

And just a reminder, the inflation rate we read or hear in the news is just the "headline" inflation.

Each household will have its own inflation rate. Just take the case of the cost of education: tuition is increasing at about 10% a year. The tuition cost in 2013 will be double in 2020. Seven years.

And I think tuition is not included in the government data on inflation...

"Wala akong pera"

I usually hear this when I invite friends to attend a seminar on investing and personal finance management.

I am quite frustrated that they don't see that the seminar COULD actually help them.

When I give them an example of P100,000 and the Rule of 72 at 4%, 8% and 12%, they get an impression that they need P100,000 to get started in investing.

I always need to remind them that provided they already know how to manage their cashflow, debts and risks, they can already start investing in mutual funds with just P5,000.

P5,000 @ 8% a year will be:
P10,000 after 9 years...
P20,000 after 18 years...
P40,000 after 27 years...
P80,000 after 36 years.

P5,000 @ 12% a year will be:
P10,000 after 6 years...
P20,000 after 12 years...
P40,000 after 18 years...
P80,000 after 24 years...
P160,000 after 30 years...
P320,000 after 36 years.

And that is assuming they will not put additional investment in the the next 36 years.  (which I highly doubt!)

(note: Rule of 72 is an approximation only and not a promise of any investment product. Rule of 72 is good for mental calculations. Use Excel of a financial calculator to find the exact time duration for the doubling effect.)

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  1. I like this rule. It's one of the few that is meant to inspire, not limit :D

  2. And it is so easy that I hope they can teach this in High School Math.

  3. Wow that's a lot of computation! This is the first time I've heard this "rule of 72" and thanks for sharing this.

    1. You are welcome! This is the "easier" way of computing time value of money. The harder way involves Excel. hehe.

      This is enough to give vision to almost everyone -- young and old, highly educated or not, male or female.


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