The Rule of 72 And Its Implications In Personal Finance And Investments

The most powerful force in the universe is compound interest. The rule of 72 is simply compounded interest expressed simply and mathematically.

WHEN I first heard about the Rule of 72, it just blew my mind. That was one of the defining moments of my life. Knowing about the Rule of 72 got me very interested in personal finance and investments.

Albert Einstein once said,

“The most powerful force in the universe is compound interest.”

The rule of 72 is simply compounded interest expressed simply and mathematically.

The importance of the Rule of 72 is that it helps you answer the following questions:

1. What is the interest rate that you will, need to have in order for your money to double.
2. In how many, years does it take for your money to double.

To determine this, simply divide 72 by a given interest rate. The result is that you get the number of years it takes for your money to double.

In order that you can understand this more clearly, let me give you an example. If you put P 100,000.00 in a bank account, it will take 72 years for your money to become P 200,000.00 since the bank only offers a 1-percent interest rate. (72/1 = 72)

Imagine if you put your P 100,000.00 in an investment vehicle that would give you a 12-percent interest rate. This time, it will only take 6 years for your money to double (72/12 = 6)

So what are some things we can learn from the Rule of 72? Here are some things, I believe, we can learn from this magical rule.

1. That money is like a fruit tree — Money is like a fruit tree, you don’t expect to plant something and get to eat its fruit the next day. What I am saying is that it will take time for money to grow. The Rule of 72 teaches you that the more time you “compound” your money, the greater will be its return.
2. The importance of learning about interest — The Rule of 72 teaches us that the higher the interest rate, the lesser time it will take for your money to double and the lesser time your money will double, the more your money will grow especially if you lock it in for a long period of time using your desired vehicle of investment.
3. That money does not grow on trees — This saying simply means that it takes “effort” in order for money to grow. There is no such thing as free money. The Rule of 72 teaches us that in order to get more out of our money, we must make an effort to get the highest interest rate and at the same time, make sure that we do not lose money in the process by engaging in “uncalculated risky investments” or too-good-to-be-true investment deals.
4.  Make money work hard for you — Some people say that we should not work hard for money but that we should let money work hard for us. I definitely agree. There is no better way to financial freedom than to let money work hard for us. Unlike people, money doesn’t get sick, money doesn’t get tired and money doesn’t complain. Since the Rule of 72 is all about the concept of compounding interest, it demonstrates for us how money, when reinvested, begets more money.
5. The concept of the “automatic money machine” — The Rule of 72 helps you understand a powerful concept in personal finance, the concept of passive income. Financial planners tell us that there are two types of income, active income and passive income. In active income, you have to do something to get income; an obvious example of this is your day job. You have to be physically present and doing something in your day job in order to earn an income. Passive income on the other hand is an “automatic money machine.” In passive income; you don’t have to do anything to earn an income. You just sit down and wait for income to come. Passive income does not come automatically, you have to do something first and afterward, you will reap the benefits and just wait for income to come. An obvious example of passive income is interest income wherein your money earns money without you doing anything to earn interest. The Rule of 72 gives you clear demonstration of what passive income is all about.

Zigfred Diaz is a registered financial planner of RFP Philippines from Cebu City.

Source: http://www.businessmirror.com.ph/the-rule-of-72-and-its-implications-in-personal-finance-and-investments/

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