The rule of 72
HAVE you ever tried to work out the effect of inflation on your savings? Use the Rule of 72. Do you wonder how long it will take for your home to double in value? Use the Rule of 72. Would you like to know an easy way to do compound interest calculations in your head? Yes, you've guessed it. Use the Rule of 72.
The best part is that you don't have to be a mathematician to use the Rule of 72. It's simple, but once you understand how to use it, you'll wonder how you got by without it. It goes like this:
Divide the number 72 by the expected rate of return - the answer is the number of years it will take for a given sum to double at the expected compound rate of return.
Suppose your home is worth $400 000 today and you predict it will increase by 7% per annum. Divide 72 by 7 and the answer is close to 10. If your prediction is correct, your house will be worth around $800 000 in 10 years time, and $1.6 million in 20 years time.
Are the figures correct? Yes the figures are correct, but nobody knows if the house values will perform as you have just predicted. If that house is worth less than $1.6 million in 20 years, the capital gain will have been less than 7% per annum.
You can use your own judgment but I have grave doubts that a home worth $400,000 today will be worth $1.6 million in 20 years.
Notice compounding coming into play.. Every time an asset doubles in value there is more growth in the last double than all the previous doubles combined. For the figures to be true the value has to rise by $800,000 in the last 10 years, but only $400,000 in the previous 10 years
Imagine where inflation would be, and interest rates, if that happened.
Noel Whittaker is a director of Whittaker Macnaught Pty Ltd. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. His email is firstname.lastname@example.org