Like so many other folks - I have an ongoing LOVE/HATE Relationship with my credit cards. In the back of my mind I have always known that 'Overspending is Bad.' (I mean, which part of 'DUH' don't I understand?)
When I learned the Rule of 72's, I thought, Why Didn't Someone Explain this to Me Before?
The "Rule of 72" is an easy way to estimate how long an investment will take to double, with a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to duplicate itself.
For example, the rule of 72 states that $1 invested at 10% would take 7.2 years ((72/10) = 7.2) to turn into $2. In reality, a 10% investment will take 7.3 years to double ((1.10^7.3 = 2). To me, close enough for government work!
When dealing with lower rates of return, the Rule of 72 is fairly accurate. This chart compares the numbers given by the rule of 72 and the actual number of years it takes an investment to double.
| Rate of Return | Rule of 72 | Actual # of Years | Difference (#) of Years |
| 2% | 36.0 | 35 | 1.0 |
| 3% | 24.0 | 23.45 | 0.6 |
| 5% | 14.4 | 14.21 | 0.2 |
| 7% | 10.3 | 10.24 | 0.0 |
| 9% | 8.0 | 8.04 | 0.0 |
| 12% | 6.0 | 6.12 | 0.1 |
| 25% | 2.9 | 3.11 | 0.2 |
| 50% | 1.4 | 1.71 | 0.3 |
| 72% | 1.0 | 1.28 | 0.3 |
| 100% | 0.7 | 1 | 0.3 |
Notice that, although it gives a quick rough estimate, the rule of 72 gets less precise as rates of return become higher. Therefore, when dealing with higher rates, it's best to calculate the precise number of years algebraically by means of the future formula. Again, close enough for government work! Get folks to pay attention how quickly these numbers double at higher rates.
Just like kids should learn about doubling their investment - the parallel is true, when someone is lending money to them - and those investors are doubling THEIR Investment on our kids!!
I wish we could teach this to all young people - before they get their first CREDIT CARD. I will do my part by starting at home.
Like so many important ideas, we understand the concept, but not the mechanics.
So often - it is understanding the mechanics, that makes the concept real!
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