Greed, Human Beings & Rule of 72
“Ponzi schemes like Madoff’s are always fueled by the desire for investments with returns higher than their risks” — Prof Meir Statman,Author — What Investors Really Want
“Indians top e-scam suckers list, lose $870 million” — Hindustan Times, July 19, 2014
“Actor Karan Singh Grover, lost 5.6L in Nigerian email scam” — TOI, June 5, 2015
The study of human mind has thrown some interesting insights on how we think. Read this para from Your Money & Your Brain — “Your investing brain comes equipped with a biological mechanism that is more aroused when you anticipate a profit than when you actually get one”
So essentially whenever we see an opportunity to make money, there is almost an “anticipatory arousal” in our mind. The anticipation of gains and what we could do with that extra money, kind of puts our guards down on the risks that are involved in investing.
Rule of 72:
For the uninitiated, the “Rule of 72” is a very important part of the Personal Financial Management. Simply said “Rule of 72” is an easy way of knowing when your invested money will double.
Formula: No of Years X Rate of Return (per annum) = 72
Example: If you are earning 8% per annum, you will double your money in 72/8 = 9 years. Likewise if you want to double your money in 5 years, you need to earn a minimum return of 72/5 = 14.4% (a tough ask!).
So this formula is a very handy tool. It’s a great way to decide what rate of return can double your money, how much time it is going to take and also a quick way for you to find out if someone is suggesting an investment that is unrealistic.
The other quick thing that Rule of 72 tells you, is how your money will grow. Let us say you invest Rs. 1L in a Fixed Deposit of 7%. It will take you 10+ years to double your money to Rs. 2L, and 20 years to make it Rs. 4L.
Greed check through Rule of 72:
Now let us see how else we can use the Rule of 72 to check our greed, the table below starts with 4% returns as in your Savings bank account:
How to use this table?
- It will take you 18 years to double your money, if you keep it in the Savings Bank Account
- It will take you 10 years + to double your money, if you invest in Fixed Deposits
- Beyond this the returns are not guaranteed, equities may double your money between 4–6 years, at times earlier as well (but do not count on it to happen with the same certainty as deposits).
- Doubling your money in 4 years or earlier should caution you, you should definitely talk to a few more people before investing. Ideally these people should not be the one’s who told you about this investment :)
Finally, it is very difficult to overcome human emotions, best is to create important checks or diversions. Rule of 72 can be one such check!