Rule of 72
Everyone has some idea of what it means to be money smart – however, whether or not you’ve acted on that idea is a different story! There are a few nuggets of financial wisdom that have become clichés, albeit practical ones. Curb your spending. Pay off your debt. Contribute to your savings early and often. Compound Interest is your friend. Start saving now and watch your money grow.
Being financially responsible starts with putting some of those clichés into action, but in doing some research into saving strategies, you might be in for an unpleasant surprise. You might do some quick calculations with current interest rates and come to the sobering realization that the effects of saving your money aren’t as mind-blowing as you thought. Why is that?
The economic landscape has changed a lot in the past 20 years. Our parents saw a time where it was possible to put your money away in a certificate of deposit (CD) with interest rates upwards of 10%. Strategically utilizing investments with that kind of return was a smart move and a great way to grow your money over time.
Unfortunately, those days of 10% interest rates seem to have disappeared along with the era of acid-wash jeans and Troll dolls. Current interest rates are at historic lows, and the Federal Reserve predicts that the trend is going to stick around for a while. Saving is, of course, still a crucial part of your financial well-being, but what’s the best way to grow your money and beat inflation when interest rates are low? Consider the following strategies:
Check Your Expectations.
There’s no way to sugarcoat it; interest rates are low right now. As a result, your investments – even with the mighty power of compound interest – just aren’t going to perform as well as they would have in the past.
Countering the effects of inflation is another resulting challenge. But don’t get too discouraged—as a young investor, time is on your side.
Even low-yield investment products can generate significant wealth over long periods of time (we’re talking decades), but it’s important to stay realistic with your long-term savings goals.
Will your investment allow you to buy your own island when you retire? It’s highly doubtful, but with some foresight and planning, your investment can allow you to retire comfortably and with peace of mind.
If you want to be realistic about your investment earnings and help plan for your future, the Rule of 72 is a handy tool to quickly estimate how many years it will take to double your investment at a given rate. The Rule of 72 works with investments that have compounding interest.
You simply divide 72 by the rate of annual return (that’s your interest rate). What results is an approximation of how many years it will take for you to double your investment.
For example, if you park $1,000 in a CD yielding 3% interest, it will take 24 years to double (72/3=24).
The Rule of 72 allows you to do some quick, back-of-the-envelope math when comparing different investment options or when planning out your long-term financial goals.
Benjamin Franklin said it best, “Money makes money. And the money that money makes, makes money.” Plan ahead and learn to use compound interest and the Rule of 72 to your financial benefit.
Time is compound interest’s best friend. Consider looking into investment products – such as dividend-paying stocks—that contribute to the effects of compound interest.
Throw a long-term investment period into the mix and you have a recipe for some compound interest benefits. Keep in mind that, as with any investment vehicle, nothing is guaranteed and you are always taking on an element of risk.
Diversifying your investment portfolio is a sound way to minimize (though not completely eliminate) your investment risk.
At the end of the day, interest rates – just like the economy itself – are unpredictable. Planning ahead is smart, but no amount of researching and strategizing will give you complete immunity from the twists and turns of market forces.