People who invest often want to know how much money they will have when they actually need it. Unfortunately, it’s hard to calculate that in your head because of the compounding effect when an investment grows.
Someone came up with “The Rule of 72.” This makes it a lot easier. Supposing you are 26 years old. You have bought an investment for $5,000, and you believe its value will increase by 6% every year. You hope to retire when you’re 62 (36 years from now). You’re curious about how much money you can expect to see when you retire.
Here’s where the rule of 72 comes in. You take 72 and divide it by your projected return rate.
72 divided by 6 = 12.
Twelve is the number of years it will take for your investment to double.
So you can expect your money to grow as follows:
The Rule of 72 is a useful trick to project investment value, but it does have its limitations. First of all, it’s an approximation. Second, it’s next to impossible to predict the performance of any investment. You should be especially wary of using the past to predict the future.
There are several things people should think about as they plan for retirement:
- Start early. If our hypothetical investor had waited 12 years to invest that $5,000, he would have wound up with only $20,000.
- Don’t try to be too clever. Almost nobody knows how to consistently outperform the markets. Don’t believe anyone who promises fantastic results.
- Be aware of your own risk tolerance. The bigger the possible reward, the bigger the risk. Don’t put your money into risky investments if you cannot put up with occasional losses.
- Be aware of costs. People saving for retirements typically invest in mutual funds. The managers of these funds need to be paid, but the costs vary very widely. Your money should be working for you rather than supporting someone else!
- Diversify. Don’t put all your eggs in one basket. Make sure that you have a mix of funds that match the time you’d like to leave your money to grow and your risk tolerance.
- Safe isn’t always safe. If you want to keep your money for a long time, you need to find ways of making it grow. Otherwise, inflation will decrease the value of your savings.