Double the Quality and Financial Abundance of Your Retirement

Understanding the “Rule of 72” Can Make a Difference

image courtesy of InvestmentZen

Among the driving, universal human needs is our seemingly incessant need for “more.” After all, it was the quest for more that drove man to discover fire, to farm the land, and to trade for goods. “More” drove Columbus and Coronado and many others to sail out across the Atlantic to the new world. It solved the mystery of travel by air and faster travel by land, and led scientists to discover cures for diseases — giving us longer, more fulfilled lives.

The drive for more is also what incentivizes us to earn money and to use that money wisely to care for ourselves and our families. As part of this quest to achieve financial freedom, sometimes we refer to “doubling” our money. To really understand this, let’s look at the “Rule of 72,” which is a shortcut to estimate how many years it will take to double your money at a given annual rate of return. It’s a time-tested investment principal taught as far back as 1494 in the Summa de arithmetica by Luca Pacioli, an Italian mathematician and one of the earliest bookkeepers.

The Rule of 72 is simple: Find the interest rate you’re earning on your money. Divide that number into 72. Your answer equals the number of years it will take to double your money.

Let’s say, for example, that you’re earning 8% interest on your money. In that case, 72 divided by 8 is 9. This means your money will double every nine years. Note that that’s based upon a one-time lump sum investment. What if you’re earning 9%? Your money will double every eight years. And if you’re earning 10%? It will double every 7.2 years.

The reciprocal of that equation is also true. If you take that number of years to double your money and divide that into 72, you’ll end up with the compounded interest equivalent (appreciation rate) it took to get there.

This Rule of 72 is often misunderstood, however. Someone may say, “I bought a piece of real estate for $200,000, sold it, and doubled my money.” That doesn’t really say much to me, however, until I know: a) how long he had to hold on to the property to double his money, or b) whether he leveraged some or all of his own money — versus other people’s money — to purchase the property.

If he used all of his own money and paid $200,000, and he kept that property for ten years before selling it for double, that’s not particularly impressive. Here’s why: 72 divided by 10 years means he got the equivalent of 7.2% appreciation — just a little less than the national average on metro U.S. real estate over the past 40 to 50 years.

Let’s now consider the effect of inflation as it relates to accumulating wealth. This is always important, because you need to know how much today’s dollar will be able to buy when you retire — and need those dollars the most.

For the sake of argument, let’s say you’re 65 years old, and, in addition to other sources of income (pension, Social Security, rental income), you need $3,000 a month to cover the extras (travel, medical, charitable giving). That’s $36,000 a year. Now, let’s say inflation is averaging 3% a year (the long term average is 3.18% from 1913–2015). At that rate, how much would you need 30 years after you retire? (Believe it or not, living to your late 80s or 90s is about the right life expectancy for today’s Baby Boomer couple.)

Let’s divide 3% inflation into 72, which means the cost of living will double every 24 years. So, if you can live on $3,000 a month now, you’ll need $6,000 a month 24 years from now.

If the inflation were to go up to 6% for the next decade, you’ll need $6,000 a month in 12 years to buy what $3,000 a month bought just 12 years earlier.

This is why it’s so essential to take a good look at the realities of inflation and the Rule of 72 — so you can be prepared, ensuring that your money lasts as long as you do.

How can this be done? Say you put your money in a financial vehicle that offers superior liquidity, safety, predictable rates of return, and tax advantages, and it’s been earning an average rate between 7 and 10%, tax-deferred. This means $1 million in the year 2001 would have grown to between $2.7 and $4 million by the end of 2016.

With your money in this type of financial vehicle that provides tax-free income, you could enjoy $200,000 to $400,000 a year — income tax-free — without depleting your principal. Despite inflation, this level of income would provide more than enough to cover the necessities. It would empower a high quality of life, with opportunities for charitable giving, as well.

Make sure to look closely at how you’re planning for your future, so you can “double” the quality and abundance of your life.

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