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Fletcher: A financial rule to follow, live by

April 3, 2012
Stephen Fletcher , The Alpena News

The Rule of 72 is a powerful and simple tool for figuring out how to grow wealth. The rule tells you very quickly and easily how soon you will double your money at different interest rates. You do the math in your head.

All you do is divide the number 72 by the expected interest rate of return on the investment and the answer tells you how many years that it will take for you to double your money. As an example, if you expect a 10 percent return, which is about what the U.S. stock markets have been returning over recent decades, just divide 72 by 10 and you get 7.2 years as the time to double your money. Try it out with different return rates and see how a 1 or 2 percent difference in interest rate affects the outcome in years.

If you pick 9 percent, the number of years it takes to double is eight. If you work until age 70, assuming that you started work at age 22, (right out of college), you will have six chances to double your income in a 48 year career. At age 30 the income would have doubled, quadrupled at age 38, eight times at age 46, 16 times at age 56. 32 times at age 62 and, 64 times at age 70. The message seems to be pretty clear - the sooner you start a saving/investment program, the better off financially you'll be.

Naturally if you start with more, you'll end up with more. If you can save $100 per week and invest it, you'll have more than $1,000,000 at retirement age.

Since there are only so many chances to double in a lifetime, the last one gives you the most bang for your buck. If you miss going from 32X to 64X, you give up the most. This last doubling is lost most often in the first years. After college graduation if you decided to travel, join the Peace Corps, or put savings/investment on hold, you effectively cut your retirement wealth in half.

There are some messages here. First, for the soon to be graduates, get as much education as you can as the lifetime earnings for all demographic groups goes up exponentially with more education. College grads earn more than high school only, post-graduate degrees earn more than baccalaureate degrees.

Second, governmental policies often thwart our efforts. With very low interest rates promulgated by the Federal Reserve Board and the mortgage/home value bubble exacerbated by the Community Reconstruction Act, our investments suffer as we aren't able to earn much on our capital, combined with the decrease in value of our single largest asset - our homes.

You should ask yourselves if you are better off than you were four years ago. The Rule of 72 will work beautifully for us if the government just lets it.

Stephen Fletcher was graduated decades ago from Cornell University with an A.B. in Economics and from Michigan State University with an M.B.A. He has lived and worked in the decades from graduation until now in the Alpena area. He thinks economics is fun and interesting.

 
 

 

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