PFT #7 - Personal Finance Tip: Rule of 72 and Compound Interest a Retirement Nest Egg
Updated: Mar 3, 2022
Today’s topic is around the rule 72.
This is a common metric and easy to calculate. The goal of the metric is to use the math to determine the number of years to double an investment.
So what is a realistic goal to start with? If you look at the S&P 500, that index on average has grown 10% since 1926.
Now we often say that it's plausible to make 7% on your money on a yearly basis.
Therefore, to use this metric, we simply take 72 and divide it by 7. So in this example, it would take just over 10 years to double your money.
Hence, $100 would take 10 years to become $200.
Now you may be thinking this is a long time to achieve this goal; however, all you’re doing is investing money and letting the stock market do the work.
So keep in mind that the Rule of 72 is a simple measure for an investment goal based on time.
So this leads us to the importance of investing on a regular basis and you can do this via tax-deferred accounts such as a 401(k), a Roth 401(k), or others such as a traditional IRA or Roth IRA or a side brokerage account.
By investing on a regular basis you benefit from dollar cost averaging and dividends which leads to compound interest which we always say “is our best friend.”
So here’s an example of how money grows:
If you saved $100 monthly for 10 years you’ll accumulate $12,000.
Now If you invest $100 per month in an S&P 500 exchange traded fund (ETF) making 7%, after 10 years you’d have $16,579.
Now that is $4,579 difference,
So what is the key takeaway?
In today’s world it is incumbent on you to build your retirement nest egg therefore, you can use the rule of 72 as a base calculation; however, in order to achieve your investment goals, you need to invest on a regular basis and protect your money
Also keep in mind, historically, the stock market always increases in value. So if you can invest, then invest regularly and your over time nest egg will continue to grow.