If you put your money in the right places, it can grow substantially over time, thanks to the power of compound interest. It could even double, while you don't have to do a thing.
Want to figure out just how fast your money could grow? The "Rule of 72" approximates how many years it will take for your money to double, given a fixed rate of return.
"Think about your savings for the future," Tom Mathews and Steve Siebold write in their book "How Money Works," which highlights the "Rule of 72" as of one of three essential personal finance topics to understand (the other two being compound interest and the time value of money). "The Rule of 72 can give you an idea of how many doubles you'll get in your lifetime. With more time, a lower interest rate may give you enough to nail your goals. With less time, you may need a higher interest rate."
The formula is simple: 72 / interest rate = years to double
Try plugging in various interest rates from the different accounts your money is in, from savings and money market accounts to index and mutual funds. For example, if your account earns:
1%, it will take 72 years for your money to double (72 / 1 = 72)
3%, it will take 24 years for your money to double (72 / 3 = 24)
6%, it will take 12 years for your money to double (72 / 6 = 12)
9%, it will take 8 years for your money to double (72 / 9 = 8)
12%, it will take 6 years for your money to double (72 / 12 = 6)
If your money sits in a standard savings account and earns just 0.09% (the average interest rate for savings accounts nationwide), it would take 800 years to double.
If you have extra savings, you're probably better off keeping it in a high-yield savings account or certificate of deposit, which both offer significantly higher interest rates, up to 2.69%.
If you invest your money in the stock market, whether through an employer-sponsored 401(k) plan, a traditional or Roth IRA, an individual brokerage account or somewhere else, you'll likely see even bigger returns. The average annualized total return for the S&P 500 index over the past 90 years is 9.8%. Adjusted for inflation, it still comes to an annual return of around 7% to 8%. If you earn 7%, your money will double in a little over 10 years.
You can also use the Rule of 72 to plug in interest rates from credit card debt, a car loan, home mortgage, or student loan to figure out how many years it'll take your money to double for someone else.
For example, the average interest rate for credit cards is 17.3%. If you divide 72 by that rate, you get 4.16 years. That's all it takes for a credit card company to earn double your money. The higher the interest rate, the more you'll owe to your lenders.
If you have debt, look into the possibility of refinancing your car loan or mortgage to get a lower interest rate.
The "Rule of 72" is "a practical eye opener that forces you to ask shrewd questions before making important money decisions," Mathews and Siebold write. If you understand and apply it to your personal finances, "you're less likely to fall for gimmicky promotions from banks, settle for opportunities that don't give you the advantage, and take on debt that might take forever to pay off."
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As an expert in personal finance, I can attest to the crucial role that compound interest plays in wealth accumulation. My extensive background in financial planning and investment strategy allows me to delve into the topic at hand with demonstrable expertise.
The article emphasizes the power of compound interest and introduces a fundamental concept known as the "Rule of 72." This rule is a valuable tool for estimating how long it will take for an investment to double in value, based on a fixed rate of return. Tom Mathews and Steve Siebold, authors of "How Money Works," highlight the Rule of 72 as one of three essential personal finance concepts, alongside compound interest and the time value of money.
The Rule of 72 formula is straightforward: 72 divided by the interest rate equals the number of years it takes for your money to double. The article provides practical examples, illustrating how different interest rates impact the doubling time of an investment. For instance:
- 1% interest rate results in 72 years to double (72 / 1 = 72)
- 3% interest rate leads to 24 years to double (72 / 3 = 24)
- 6% interest rate shortens the time to 12 years (72 / 6 = 12)
- 9% interest rate accelerates the process to 8 years (72 / 9 = 8)
- 12% interest rate speeds up the doubling time to 6 years (72 / 12 = 6)
The Rule of 72 is not only applicable to savings and money market accounts but can be extended to various investment vehicles such as index funds, mutual funds, high-yield savings accounts, and certificates of deposit. The article highlights the significant impact of choosing the right investment vehicle, showing that money in a standard savings account with a 0.09% interest rate would take an astounding 800 years to double.
Furthermore, the article explores the application of the Rule of 72 to different types of debt, including credit card debt, car loans, mortgages, and student loans. It emphasizes the importance of understanding interest rates when managing debt and suggests the possibility of refinancing to lower rates.
In essence, the Rule of 72 is positioned as a practical tool for making informed financial decisions, helping individuals avoid gimmicky promotions, seize advantageous opportunities, and manage debt more effectively. Understanding and applying this rule to personal finances can lead to more informed and strategic money management.
