“The most powerful force in the universe is compound interest” is often quoted in reference to Albert Einstein. Yet many scholars believe that the man never uttered the words and the line was a simple catch phrase used frequently in financial presentations to catch the attention of novice investors.
It’s important to realize that compound interest isn’t some gimmick or sales pitch from a mutual fund company in order to help sell you something. It’s not an invention by someone who sat down & realized what they could do with numbers; it’s real. For many investors it’s something that they fail to recognize as having the potential to impact their portfolio in a dramatic way. It’s also not a complicated formula that you need a mathematics degree in order to decipher; it’s just simple numbers.
Many people never realize that the “Rule of 72” is actually what we all ask ourselves or others when we ask the question “How long until my money doubles?” That’s essentially what the tool is used to figure out.
First you need to understand the simple method of how compound interest works:
If you borrow $1000 at 5% annually, then the interest on that principle is $50/year. Normally you would pay down both the interest & principle, but compound interest works as if you let it build up over time. So if you left that loan for 5 years without paying a cent this is how the yearly balance would go:
The importance is to realize that the sooner you can double your investment return, the faster your accent on the exponential curve.
So the “Rule of 72” is a simple answer to the question of “how soon will my investment double?” If you take your rate of return (5%, 10%, 15%) and divide 72 by that number, you’ll get the number of years it will take for you to double your investment if that return remains the same.
Where would you like your portfolio to be on this curve?