If you’ve ever wanted to convince someone else or yourself about the power of compounding – and why they should begin investing today – then the “Rule of 72” is a useful rule of thumb to depict its benefits. The “Rule of 72” is a simple way to estimate how many years it takes for your investments to double, compounded at a fixed annual rate of return. To enjoy the effect of compounding, you must also reinvest your yearly returns and strive to receive the same annual rate of return each year. What does the “Rule of 72” say? Remember that this rule of thumb is not a substitute for proper calculations, which typically require a scientific calculator and a good understanding of logarithms. That being said, it is a really handy tool to quickly derive a relatively accurate estimate for how long it takes to double your investments. Here’s the “Rule of 72” formula: Years required to double your investments = 72 / Compound Annual Interest Rate (CAGR) Simple? For example, the CPF Special Account currently gives 4% in interest per annum. Thus, using the “Rule of 72”, it will take 72/4 = 18 years for our monies to double. The actual number of years is 17.67, which shows the “Rule of 72” is pretty close. If you are able to achieve a higher rate of return, even by a few percentage points, you will drastically shorten the amount of years required to double your investments. Similarly, if you receive a lower rate of return each year, you may take a much longer time to double your investments. Here is a table of annual compounded interest rates, and what the “Rule of 72” gives, compared to the actual number of years.
In general, the “Rule of 72” gets you quite close to the actual figures, though it may become pretty inaccurate once interest rates are at 20% and higher. If you’re able to achieve such interest returns on an annual basis over a long period of time, it’s safe to assume you will be able to derive such complicated calculations on your own. Applications of Rule of 72 The Rule of 72 could apply to anything that grows at a compounded rate, such as population, GDP growth and even inflation, investment returns or fees. For most, returns and fees are important figures you may want to calculate before making an investment. You can use the table above to estimate how long your investments will take to double, and how long more you need if you factor in annual investment fees. The rule can also be used to find the amount of time it takes for your money's value to halve due to inflation. If inflation is 6%, then a given purchasing power of the money will be worth half in around (72 ÷ 6) = 12 years. If inflation decreases from 6% to 4%, an investment will be expected to lose half its value in 18 years, instead of 12 years. This is also another important reason to invest, and to receive an investment return that beats the inflation rate. What can the “Rule of 72” teach us? The Rule of 72 depicts how even a “small” 1% difference in inflation, fees or investment return can have a large effect in forecasting models. If you wish to double your money, receiving a single percent less can extend the number of years you need to reach your goal. This also highlights the importance of carefully evaluating the potential returns of each investment product, after accounting for fees and costs. These differences can add up significantly over the long run and have a big impact on your retirement plans. Secondly, the rule elegantly illustrates the “magical” power of compounding. If you diligently invest and receive even a modest rate of return (4% to 5%), you can actually double your initial capital in less than two decades. In order to allow this compounding to work, all that’s needed is time and diligence. By planning for one’s retirement early and starting to invest today, you can ensure you’re growing your retirement nest egg so that it will be ready for your retirement needs in your golden years. Someone who starts investing only in their forties may need to contribute many times more money to their retirement funds, but will still not have a larger retirement nest egg compared to someone else who started in their thirties or even twenties. This is because they were not able to leverage on time to compound their investments. Helping you plan for your retirement today To help you invest for your retirement, while protecting you today, the AIA Pro Lifetime Protector is a comprehensive all-in-one solution that allows you to personalise your protection in the early years, and make adjustments to your coverage to maximise your investment returns during your later years. You can enjoy comprehensive coverage against death, disability and multi-stage critical illnesses from as low as S$6 a day, while accumulating your wealth at the same time. For peace of mind, the AIA Pro Lifetime Protector also provides you with guaranteed protection for the first 10 years, regardless of your investment performance. What does 5% compounded annually mean?Compound interest is the interest you earn on interest. This can be illustrated by using basic math: if you have $100 and it earns 5% interest each year, you'll have $105 at the end of the first year. At the end of the second year, you'll have $110.25.
What is the growth rate of a double in 5 years?Similarly, if you want to double your money in five years, your investments will need to grow at around 14.4% per year (72/5). If your goal is to double your invested sum in 10 years, you should invest in a manner to earn around 7% every year. Rule of 72 provides an approximate idea and assumes one time investment.
|
