The Rule of 72
- The Rule of 72 makes it simple to get the concept of what happens to money as it compounds over time.
- Using this rule puts things in context when you are trying to make a decision about your money and can quickly help you eliminate certain decisions.
NCIS is a show that’s been on for about 14 years, and the actor Mark Harmon plays a character called Gibbs on the show. Gibbs has all these rules he operates on. There’s Rule 12 where you don’t do this, or Rule 15 where you always do that, and many other rules that he brings up throughout the show. Gibbs’ rules remind me of something in the financial world that helps make life a little simpler: The Rule of 72.
The Rule of 72 says that, if you take an interest rate and you divide it into 72, the resulting number would equal the number of years it would take your money to double. For example, if you have $100,000 at an interest rate of 6%, it would take 12 years for that money to double.
Why is this important? Sometimes putting things in context when you are trying to figure out whether one decision makes more sense over another, makes a difference.
Let’s say you decide at age 55 that you are just going to put everything you have into bonds. You have a couple of million dollars and we’ll say bonds make an average of 4% a year – that’s long term, not what’s happened recently. Based on the Rule of 72, we know your money will double every 18 years. Perhaps you will have two doubles in your lifetime. However, we first must take out the money we need to live on, let’s say 3%, and inflation, which is 3%, to really see what the value of that money is in the future. If you take that total of 6% off, now you have -2%, so that money now cuts in half in 36 years.
See how that worked out? Your money is doubled if it is gross, but you know it won’t be with inflation and spending needs, so it could actually turn in to half of what it is right now. Probably not a decision you will be happy about in the future.
Using the Rule of 72 as a quick rule of thumb is a simple way to see the future of your money. It eliminates certain things very quickly from your decision making process and makes it simple to get the concept of what happens with money as it compounds over time, both positively and negatively.
Until next time, enjoy.
Gary Klaben is in our Glenview, IL office and serves our clients who are now located all over the country. Instead of being afraid of change, Gary is always looking at how technology will effect clients and bringing the best of it into the practice. Whether advising his clients, mentoring his team, or coaching entrepreneurs, he is always simplifying complexity and motivating others to take the next action that’s right for them.
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