When it comes to personal finance, everyone’s an expert. There are so many rules to adhere to and tips to check out, it can be somewhat overwhelming. But in the world of finance, there’s a little well-known secret that some experts swear by. It’s a way to help you save money. Unfortunately, it can also be used against you, too.
This little secret is called the Rule of 72. It’s often used to calculate how long it will take your money to double. For example, if you invested $2,000 in a stock, and your rate of return is 6% interest. You divide 72 by 6—which equals 12. This means that in 12 years, your investment will double to $4,000. This investment will also continue to double every 12 years, which means in 24 years, you’ll be looking at $8,000.
If your rate of return is 10% interest, you would divide 72 by 10, which means it should take you 7.2 years for you to double your money. Or, if the rate of return is 2% interest, then it would take you 36 years to double your money.
Equations related to calculating compound interest are often very complicated, which makes the rule of 72 a great shortcut that you can use without having to reach for a calculator. The equation that one would have to use to find out exactly how long it would take to double his or her investment that, for example, returns 8% annual, the equation would look a little more like this:
T = ln(2)/ln(1.08)=9.006
Evidently, the Rule of 72 is much easier to use, since 72 can divided by easily in one’s head by many numbers.
With the Rule of 72 in mind, it’s also crucial to understand that the financial market often fluctuates at any given moment. According to The Balance, the market gave returns as high as 37% and as low as -37% between 1987 and 2012. What this means is that the Rule of 72 really only gives you a general average. Given what can happen in the market, it’s important to stay consistent and patient with its changes.
The downside of the Rule of 72, however, is that it can also be used against you, with it applied to put you into debt. Financial institutions, banks, credit card companies, and other such lenders may use the Rule of 72 through charging you interest rates.
For example, if you owed a credit card company $10,000, and your credit card offers the average interest rate of 18%, this would mean that your debt would double in four years to $20,000. In eight years, you would be in $40,000 worth of debt. This is how financial institutions make their profits. Of course, this should only act as a cautionary tale.
Now that you know how the Rule of 72 works, you should be able to calculate exactly what you’re getting yourself into before you sign on for a new loan. Whenever you are looking to borrow some money, make sure you read all the fine print and consider whether or not it’s realistic within your financial situation to take out a loan of that size.
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