The Rule of 72

If you are just beginning to start saving for your future - or you are a novice investor trying to figure out how far you can multiply your savings - this is what you are probably asking yourself “How long will it take to double my money?” It is actually quite simple to figure this one out once you know the right formula to apply.

In financial planning there is something called the Rule of 72 that is commonly used to gauge how your original investment will fare at a given rate of interest. This is how you apply the formula: Just divide the number 72 by the annual return expected on your investment. The answer gives you the number of years you need to double your money. For example, if you invest $10,000 at a 10% rate of interest, you double your money in 72/ 10, that is, 7.2 years time. If you manage to park the same funds, for example in a fixed deposit, such as a bank CD, that pays you a rate of 14%, this may help double the sum sooner, in slightly more than five years.

Is your Interest Compounded Annually?

Before you start planning for what to do after possibly doubling your money, make sure that your savings earn compounded interest, which means that the interest is paid on your principal sum plus interest earned thus far. Compounding can be one of the simplest and more effective ways to let your savings grow optimally. Although the norm is to compound annually, there are investment avenues where this happens at more frequent intervals too.

To understand why compounding can be your best option, compare these two hypothetical scenarios. In the first one simple interest is being computed and in the second interest is compounded on a yearly basis on the same initial savings.

·         Investing $10,000 at 10% simple interest for 5 years: At the end of five (5) years you have a total of $15,000.  ($10,000 x 10% = $1,000 so adding ONLY the interest on the original amount to this each year $1,000 x 5 = $15,000)

·         Investing $10,000 at 10% compound interest (annually compounded) for five (5) years: At the end of five years you have a total of $16,105. ($10,000 + 10% = $11,000 + 10% = $12,100 + 10% = $13,310 + 10% = $14,641 + 10% = $16,105)

In these examples, compound interest is the way to go. Also, it's evident in these examples that compounding yields maximum benefits if you start saving early. If you are working to build your retirement fund, then investing a small amount that yields compound interest every year right from the beginning of your career help provide you with great results.

However simple the rule, discovering the right investment avenues and knowing how much to save to help provide a secure financial future can be a complex and challenging task. Talk to Lee Rawiszer, Managing Principal of Paradigm Financial Partners about options to maximize your retirement.  

The examples included in this posting are hypothetical in nature and do not represent an actual investment. There is no guarantee similar results or rates on investments can be achieved.  If fees had been reflected, the return would have been less.