In the midst of a client meeting a Financial Planner will often be required to perform some swift arithmetical gymnastics to quickly get to a solution or an answer to keep the conversation flowing. Over time, patterns within numbers and familiar equations performed enough times become etched in the brain.
Sometimes, a simple tool can be used and so we thought we might share this one which we use every day and has any number of practical uses in every day life.
Albert Einstein once said: ‘Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.’
Compound interest is essentially where interest is paid on the interest already accrued as well as the initial capital. This means that the capital increases exponentially rather than linearly.
But how quick is the increase in investment value?
The rule of 72 is an easy way to determine how long it will take an investment to double in size.
The rule of 72 is as follows:
t = number of years an investment’s value takes to double.
r = the annual return %.
It means that 72 divided the average annual rate of return is how many years it will take for the investment to double. For bdb’s 100% equity portfolio, which has an expected annual return of c7%, it would take an investment about 10 years to double. For the bdb’s 60% equity portfolio (c6% per annum), it would take 12 years to double and for the bdb 40% equity portfolio (5.5%), 13 years.
The same rule can be applied to debt. For example, debt on a credit card with an interest rate of 20% per annum would take just 3.6 years to double.