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For many, the thought of retirement planning makes people queasy. A study by the Savings Council shows that Most American’s spend more time planning a two-week vacation than planning their retirement. Saving and investing for retirement can be intimidating. A lot of people just are not comfortable working with numbers.
If you are one of those people, pay attention, because there is a simple concept called The Rule of 72 that can give you more confidence in your decisions. It is one of my favorites because you do not need to use any math skills beyond addition, subtraction, multiplication and division. You can use it to instantly compare the advantages or disadvantages of financial decisions.
First I will explain how the rule works and then I will give some practical applications.
The Rule of 72 tells you how quickly your money will double. Simply take the rate of return you expect to earn on your money and divide that rate into 72. For instance if you put your money in a CD that is earning 4.8%, take the 4.8% and divide it into 72 (72 divided by 4.8 = 15). Your money doubles every 15 years if you earn a 4.8% rate of return every year.
As a practical application, assume you and your spouse are 40 years old and have inherited $30,000. Your spouse would like a new car but you are concerned about how little money you have saved for retirement. Point out to your spouse that $30,000 put in a mutual fund earning the historical average of 10% annually will double to $60,000 in 7.2 years (72 divided by 10% = 7.2 years). It will double again to $120,000 by the time you are a little older than 54 years old. In 7.2 more years when you are still 61 you will have $240,000. And of course in your 68th year your nest egg will swell to $480,000.
Armed with this information, ask your spouse if they really need that new car when there is a good chance you can add almost half a million to your retirement savings. To bolster your case, point out that $480,000 earning 5% in a tax free bond will supply the family with $24,000 in additional retirement income ($480,000 x .05 = $24,000).
The Rule of 72 can also help you decide where you need to put your money today to have the amount you need in later years. Lets say your daughter is eight years old and you have $30,000 put away for their college education. You determine you will need $60,000 by the time she turns eighteen. Using The Rule of 72 you can calculate that you need to get a return of 7.2% per year on your $30,000 in order for your money to double to $60,000 in ten years. Simply divide the number of years you have into 72 and you will get the rate of return needed (72 divided by 10 = 7.2). Knowing the rate of return will help you decide how much risk you need to take to meet your financial goal.
Numbers can be intimidating but they dont lie. Once you understand how they work it is easy to get more committed. Hopefully The Rule of 72 will make your job easierGood Luck.