Click our video above to watch John O'Rourke, Vice President of Private Banking & Wealth Advisor, discuss the power of using the Rule of 72, the impact it can have on your investments over time, and how it can help you reach your financial independence.
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[On screen text- Investment Insights: The Rule of 72]
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[On screen text: John O’Rourke – Vice President, Private Banking & Wealth Advisor – First American Bank]
John: Have you ever heard of the Rule of 72? Well, if you have, I’d still encourage you to stay tuned because I’m going to talk about the Power of 72 and how it can be used to help you reach your financial independence.
The Rule of 72 has been around for quite some time and was first cited back in the days of Leonardo Da Vinci by an Italian friar named Luca Pacioli who has also been called the father of accounting. Essentially, it’s a simplified formula for calculating how long it’ll take for an investment to double in value based upon its rate of return. The Rule can basically be applied to anything that grows at a compounded rate and is fairly accurate.
For example, let’s say that you have $100K invested in the market, you’re earning a 6% rate of return and you’d like to know how long it will take for your money to double in value. The calculation is pretty straight forward and all you have to do is divide 72 by 6 and you’ll get 12 years! This simple calculation can prove to bey quite useful when planning for your retirement, saving up for the down payment on a house or…trying to understand the impact of annual fees on your borrowings and investments.
While most of us will focus on our investment ‘returns’, we often lose site of the ‘impact’ that fees can have on our investment’s growth over time. For example, many of us know the importance of putting aside money for the future and investing in professionally managed mutual funds is a great option. When reviewing a funds historical returns, also take the time to understand the fees being charged. Applying the Power of 72 can be helpful in understanding the impact that these fees will have on your investment over time. Let say that a fund charges 3% in annual fees, take 72, divide it by 3 and you’ll end up with 24, which essentially tells you that the fees your being charged will cut your investment principal in half within about 24 years. This is significant particularly when you consider that most mutual funds are used for long-term retirement savings. Choosing quality funds with fees of 1% or less will make a huge impact in your savings balance over time.
Many of us carry a variety of personal debt – like credit cards/ student loans/ mortgages and auto loans to name a few. The Power of 72 can provide you with some valuable insight on virtually any loan that is charging compound interest. Paying 12% on your credit card seems pretty cheap considering that the median rate exceeds 19%*. That is until you realize your balance will virtually double in just 6 years. What about that 7% student loan you’re carrying? Double in just a tad more than 10 years.
Determining the rate of interest needed to double your investment can be valuable when understanding the power of compounding and how risk is related to desired returns. Even more eye opening is understanding the power of compounding on your loans and investment fees, which can really eat away at your savings goals over time.
Feel free to drop any comments or suggestions below! I’d love to hear from you.
*Investopedia May 18, 2021 article “Average Credit Card Interest Rate”
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