Tuesday, September 11, 2012

How to Get Rich - Understand the Number 72

Do you know what is significant about the number 72 ?

Do you know why it is so important to building wealth ?

If you read my last posting you do !

72 is a Magic Number

Further to my last posting, I would like to explain further why the number 72 is such an important tool for you to use in building your wealth.

As previously explained, the rule of 72 states that if you divide the number 72 by your investment's current rate of return and assuming you reinvest all of your compounding  income once a year at the same rate of return, the resulting answer will be the number of years it takes to double your money.

Ok, pretty straight forward. But why is it so important to building your future wealth ? Let me explain by example.

Suppose you invest $10,000.00 at a  yield of 10% rate of return paid annually.
If you reinvest your annual income every year your investment would be worth $20,000.00 in 7.2 years.
Now suppose your investment only yields a 5% rate of return paid annually. If you reinvest your annual income every year it would take 14.4 years before your investment would be worth $20,000.00  (72 divided by 5)

Why So Important

The above example shows just how important it is to find investments with the highest possible yield. Of course most investments fluctuate in value and can even decrease in value over time. Therefore, the rule of 72  should only be used as a guideline for forecasting future valuation levels.It is basically a tool used for estimating future values and in real life will never be exact.

It also does illustrate how valuable it is to invest your money versus leaving it in a bank savings account. The best bank accounts currently pay a yield of only 2% at best. Leaving your money there would take you 36 years to double your money. (72 divided by 2) Not a wise choice.

72 and You

Get comfortable using the rule of 72 and you will be able to see if a potential investment is suitable or basically good enough for your investment portfolio. Remember though, if an investment does not pay out regular income, the rule of 72 will not help in your forecasting. This is because you have no basis for your future growth other than guessing that your investment will rise in value each year. In reality, all investments, good and bad, rise and fall in value over time and are subject to many variables and risk factors.

The rule of 72 is merely one of the many tools at your disposal to aid in your building of future wealth. Use it for estimating your future values and comparing the effects of different investment choices. It will serve you well.

As always, I welcome your comments and suggestions for future topics.

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