Wealth Building Lessons

March 14th is Albert Einstein’s birthday! And in case you’re ever on “Who Wants To Be A Millionaire”, he was born in 1879. Apart from his general theory of relativity he’s also allegedly famous for claiming that Compound Interest was one of the greatest mathematical discoveries of all time. He’s also credited with the rule of 72.

The Rule of 72

The Rule of 72 lets you calculate compound interest returns in your head and helps you quickly determine how good a potential investment is likely to be.

The rule of 72 says that in order to find the number of years required to double your money at a given interest rate, you can just divide 72 by the interest rate.

For example, if you want to know how long it will take to double your money at eight percent interest, divide 72 by 8 and you get 9 years.

The rule of 72 is remarkably accurate, as long as the interest rate is less than twenty percent.

You can also run it backwards. If you want to double your money in four years, just divide 72 by 4 to find that it will require an interest rate of about 18 percent.

So while Benjamin Franklin may have said “A penny earned is a penny saved”, how that penny is invested will determine whether you’re eating canned dog-food in your retirement years or have a personal chef and live in Beverly Hills.

I had a friend ask me today if she should invest in a local Credit Union’s IRA CD. It pays a whopping 5% for a 6 month CD if you opened an IRA with them. If you have over 30 years left to retire why would you invest in a CD? There are Canadian Income Trusts that return 12% per year and pay out dividends every month!

Using the Rule of 72, we see it takes 14.4 years to double your money at 5%. At 12%, it only takes 6 years! So in 14.4years, I’ve doubled it twice! Over a 30 year period, the difference would be astronomical. A $4,000 investment at 5% would grow to $17,287 while at 12% with the monthly dividends re-invested amounts to $143,798. And if you contribute $4,000 every year for the next 30 years, the difference is a whopping $1 million! ($1.3 million vs $296,000). Don’t you think a $1 million difference would cramp your lifestyle a little bit? Creating wealth sometimes requires you to step out of the box of “convential” investments.

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