RPF0452-The_Rule_of_72
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00:00:29.800 | Today on Medical Personal Finance we talk about the rule of 72.
00:00:37.120 | One of those very useful little mental math shortcuts that you can use to estimate the
00:00:43.960 | effect of various growth rates and calculate how long it takes you to double your money.
00:00:50.680 | Welcome to Radical Personal Finance, the show dedicated to providing you with the
00:01:09.680 | knowledge, skills, insight and encouragement you need to live a rich and meaningful life
00:01:14.440 | now while building a plan for financial freedom in 10 years or less.
00:01:18.120 | Hey, guess what?
00:01:19.120 | If you're going to do 10 years or less, do you know how much money you need at the end
00:01:21.880 | of 10 years?
00:01:22.880 | And do you know how long it'll take your money to double in 10 years?
00:01:27.800 | What interest rate you need to double your money in 10 years?
00:01:30.520 | That's why the rule of 72 is useful.
00:01:39.160 | Jumping back into the financial planning shows here today.
00:01:41.920 | I've been on hiatus for quite a while here on Radical Personal Finance.
00:01:45.200 | Traditionally, I like to do Wednesdays as a financial planning show.
00:01:49.440 | And the reason for that – I know for some of you, financial planning shows have been
00:01:53.760 | your favorite.
00:01:54.760 | That was what brought you here to Radical Personal Finance.
00:01:56.320 | You said, "Hey, Joshua says he's teaching his way through the CFP curriculum and that
00:02:00.240 | has been my intention and my intent."
00:02:03.240 | And so that brought a number of you here.
00:02:05.840 | What I learned in doing the financial planning shows is as measured by download numbers,
00:02:12.400 | meaning popularity of the shows, there tends to be quite a bit of variability among different
00:02:17.120 | shows.
00:02:18.120 | I know that some people are subscribed to the show where their phone, the app on your
00:02:23.120 | phone just simply automatically downloads every show.
00:02:26.000 | But many people don't listen to every show.
00:02:27.500 | Many people just simply dip in and dip out when they want to and they choose based upon
00:02:31.640 | the title that sounds interesting to them.
00:02:35.240 | And so I can see the variability of different shows.
00:02:37.760 | I can measure what's more popular and what's less popular based upon the number of downloads
00:02:43.000 | of a show and that could just simply be what's more popular in terms of the title of a show
00:02:48.120 | or what's a catchier title, et cetera.
00:02:50.560 | So I can also then judge the popularity of shows based upon the actual feedback that
00:02:55.600 | I get, the emails that I get, the comments that show up on the show page, et cetera.
00:03:00.940 | So traditionally, as I've been doing these financial planning shows, they have often
00:03:07.120 | been my least popular shows, some of the shows that have been downloaded the least and also
00:03:13.680 | from a preparation perspective, they take me the most time to prepare.
00:03:18.960 | When I do some complex show trying to go over various types of annuities or types of life
00:03:23.600 | insurance, et cetera, in order to get that content clear and concise, it takes a tremendous
00:03:29.960 | amount of preparation time to do that.
00:03:32.920 | So I haven't had a huge motivation to follow through on these financial planning shows
00:03:37.520 | seemingly because the audience doesn't seem to resonate with them as much as with other
00:03:41.600 | topics and it takes a lot of time.
00:03:44.600 | That said, it is still important to me to do so.
00:03:47.620 | And today, we're going back to my outline of certified financial planner topics and
00:03:52.800 | crossing off one here called the Rule of 72, just a quick little valuable – hopefully
00:03:58.000 | valuable tool and little piece of math, a little mental math shortcut that I want you
00:04:04.600 | to be equipped with.
00:04:05.600 | That's the purpose of today's show as we get back to the CFP curriculum.
00:04:09.680 | I don't promise to give you one of these every Wednesday.
00:04:12.200 | I will do my best to do them consistently and I have some chosen but it's largely
00:04:16.960 | based upon what I'm able to do and when I'm able to do it.
00:04:20.320 | So please be patient with me as I do my best to deliver the content for you on a consistent
00:04:24.440 | basis.
00:04:26.080 | The Rule of 72 is a mental math shortcut that you can use to calculate how long it will
00:04:32.320 | take a pot of money to double.
00:04:34.520 | It doesn't have to be money.
00:04:35.520 | It just basically measures how long if you have a mathematical quantity that is going
00:04:44.640 | to be governed by compounding interest, how long will it take that to double or to have
00:04:50.420 | if you're going the other way.
00:04:51.960 | The way that you do this math is you take the number 72 and you divide it by the interest
00:04:58.160 | rate and you can generally do this in your head and get a good rough idea of how much
00:05:02.960 | money we're going to be talking about.
00:05:05.140 | So very simply, if for example you think that you can earn 6% on your money, then you just
00:05:11.960 | simply take 72, divide by 6 and the answer of course that you get is 12, 12 years.
00:05:19.920 | Six times 12 is 72.
00:05:21.760 | So you get 12 years.
00:05:23.920 | That's how long it will take for your money to double.
00:05:26.080 | $100,000 in the bank invested at 6% interest will equal $200,000 at the end of 12 years.
00:05:35.760 | If you want your money to double every decade, you can calculate what interest rate you require
00:05:41.480 | in order to accomplish that.
00:05:43.280 | So you would take as a simple example, 72 divided by 10 and that's 7.2%.
00:05:48.120 | If you have a million dollars, you don't spend any of the money, if you can invest
00:05:52.920 | it at 7.2%, at the end of a decade, you'll have $2 million.
00:05:57.960 | And that process then could be repeated the following decade.
00:06:02.720 | Now of course compounding works against you the other way.
00:06:05.880 | If you're using this to compare an expense, for example something like inflation, then
00:06:13.520 | you'll see the effect go the other way.
00:06:14.880 | On yesterday's – yesterday's show?
00:06:17.040 | Yesterday's show, I talked about – yes, excuse me, where I talked about the numbers
00:06:22.320 | of a million dollars value of 1998 when Tom Stanley first published his book The Millionaire
00:06:27.360 | Next Door.
00:06:28.360 | Here in 2017, I said that if you were a millionaire back then, you need a million and a half dollars
00:06:34.200 | to have the same purchasing power that you had back then.
00:06:37.720 | Well, that's coming up on 20 years.
00:06:40.280 | And if you wanted to say, well, how much would it be to double?
00:06:44.680 | What if I had to have $2 million?
00:06:45.840 | What would an inflation rate be for me to have to have $2 million in 20 years?
00:06:51.240 | The answer would be three and a half percent.
00:06:53.360 | 72 divided by 3.5 comes out to about 20.
00:06:58.500 | So there's where we get our 20 years.
00:07:00.560 | It's a big deal because just a small move in inflation rates means that your money is
00:07:06.760 | losing value much more quickly.
00:07:08.280 | If inflation rate goes from 2 percent to 3 percent, which is a very normal calculation,
00:07:16.040 | the number that I used yesterday was I believe the inflation calculator I plugged that number
00:07:19.960 | into is like 2.5 percent, somewhere around there.
00:07:22.920 | But if you used – if the inflation rate goes from 2 percent to 3 percent, that means
00:07:27.080 | that your money will lose half of its value in 24 years instead of 36.
00:07:33.000 | That's a decade.
00:07:35.320 | That's a big, big difference when it comes to inflation rates.
00:07:39.320 | Of course also you can use this for expenses that you may face.
00:07:43.120 | So there's the cost of healthcare or the cost of college tuition.
00:07:49.280 | You can take that number.
00:07:51.120 | Let's say that cost of healthcare, cost of college tuition is going up at 5 percent
00:07:55.280 | per year, then that means that about 15 years from now, you're going to have double the
00:08:03.320 | expenses.
00:08:04.320 | 72 divided by 5 equals 14.4.
00:08:07.280 | So let's call that 15 years from now.
00:08:10.720 | Now why is this useful?
00:08:12.640 | It's useful because it has a way of translating something that we don't particularly know
00:08:18.880 | how to connect with, interest rates, into something that we do know how to connect with
00:08:25.260 | a little bit easier, money doubling and money doubling in a certain number of years.
00:08:32.760 | If I talk about investment A that has the potential to return a 5 percent interest rate
00:08:38.120 | or investment B that has the potential to return 7 percent interest rate, depending
00:08:44.680 | on your familiarity with investing, that might or might not sound like a big deal.
00:08:50.120 | For most people, the difference between 5 percent and 7 percent doesn't sound like
00:08:53.280 | a big deal.
00:08:54.440 | But the rule of 72 tells us that if we invest at 5 percent, our money will double in 14.5
00:09:01.600 | years or if we invest at 7 percent, our money will double in 10.5 years.
00:09:09.320 | So we can see here that that small, relatively small 2 percent difference, when we put that
00:09:15.980 | into a compounding formula, it makes a huge difference on how quickly our money grows.
00:09:22.800 | If you are 30 years old and you can double your money every 10 years versus every 15
00:09:31.120 | years, that will make a huge difference in how much money you have at the age of 70.
00:09:39.840 | The person who is investing their money at 7 percent, thus doubling their money every
00:09:44.960 | 10 years, has the opportunity to have four entire doubles.
00:09:51.380 | Their money can double over four times once per decade.
00:09:54.840 | The person who's investing at 5 percent, on the other hand, has 40 years investing,
00:10:01.600 | has the possibility of doubling their money only 2.78 times.
00:10:06.160 | So it's called 2.8 times.
00:10:08.040 | Well, when you think about, let's say you have $200,000 a day, $200,000 doubled four
00:10:14.440 | times leaves you with $3.2 million after the fourth doubling.
00:10:20.480 | But if it's only doubled three times, that leaves you with $1.6 million after the doubling.
00:10:26.040 | This is a big deal, huge deal.
00:10:28.520 | I think personally I'm probably guilty of being somewhat cavalier when it comes to interest
00:10:34.400 | rates here on the show.
00:10:36.120 | I generally try to make conservative estimates and I use various numbers at various times,
00:10:42.880 | but I shouldn't be so cavalier and you shouldn't get the impression that there's a small difference
00:10:48.140 | between a 5 percent rate of return and a 7 percent rate of return.
00:10:54.040 | There's a huge difference between those two numbers.
00:10:57.720 | It's a big, big deal.
00:11:01.420 | That's why when it comes to investing, everything matters.
00:11:05.560 | The fact that you invest the portfolio into an investment that has a higher probability
00:11:12.160 | for a high, excuse me, that has a high probability for a higher rate of return, something moving
00:11:17.600 | towards 7 percent or 8 percent or 9 percent or 10 percent because if you're investing
00:11:23.320 | in stocks and bonds because it's more heavily weighted to stocks, that's a big, big deal.
00:11:31.560 | The fact that you choose CDs or money market account and don't invest in stocks, that's
00:11:36.080 | also a big, big deal.
00:11:39.520 | Expenses are a huge deal.
00:11:43.400 | If we use the rule of 72 and we say if you're getting a 6 percent rate of return, 72 divided
00:11:50.580 | by 6 equals 12.
00:11:52.460 | Your money will double every 12 years.
00:11:55.560 | However, if we use a 7 percent because you can trim off a 1 percent worth of expenses,
00:12:02.040 | 72 divided by 7 means that your money will double every 10.29 years.
00:12:07.440 | Let's calculate the impact over a 40 or 50 year investment time horizon.
00:12:11.960 | It could be huge, much bigger when you go longer than that, but let's just stick with
00:12:16.280 | 40 years.
00:12:17.280 | 40 divided by 12 means that your money could double 3.33 times at 6 percent, but 40 divided
00:12:24.440 | by 10.3 means that your money can double 3.88 times over the course of your 40 year investment
00:12:34.480 | career.
00:12:35.960 | 3.33 doubles versus 3.88 doubles is a big deal.
00:12:42.680 | Think about your money at the end of your investment career and just think about that
00:12:48.440 | number.
00:12:49.440 | Let's say it's a million dollars and think about the hundreds of thousands of dollars
00:12:53.500 | that are represented by another half doubling period.
00:12:57.240 | I'm getting a little tongue tied here with all these numbers in an audio format.
00:13:01.560 | I apologize for that.
00:13:02.800 | I want to impress upon you the fact that interest rate matters.
00:13:09.400 | Expenses matter.
00:13:10.520 | Tax efficiency matters.
00:13:11.800 | All of these things matter.
00:13:13.080 | It's a little hard for many people to sit down with a spreadsheet, build a spreadsheet
00:13:18.560 | that's going to show the impact of various rates of return and being able to visualize
00:13:23.640 | it.
00:13:24.640 | Sometimes it's a little easier for many people to recognize how quickly their money is going
00:13:29.680 | to double and how many doubling periods they can have.
00:13:33.440 | The rule of 72 will help you get there.
00:13:35.640 | I encourage you to use this.
00:13:37.240 | If you're ever wondering how long will it take money to double or how long will it take
00:13:41.680 | an expense to double, just take 72 and divide it by the rate.
00:13:48.000 | Hopefully that will allow you to get around some of the problems of the money, the big
00:13:53.880 | numbers which are hard for our brains to conceive of and conceptualize.
00:13:58.200 | You'll be able to create a more accurate analysis for yourself.
00:14:02.960 | That's it for today.
00:14:03.960 | That's it for the rule of 72.
00:14:04.960 | It's as simple as that.
00:14:07.320 | But I can check the box now on my curriculum that we've talked about the rule of 72 on
00:14:11.360 | the show.
00:14:12.360 | Thank you for listening to the show.
00:14:13.800 | For those of you who have been sending me voicemails for the episode 500 show, please
00:14:19.120 | keep that up.
00:14:20.120 | You can send those to Joshua@radicalpersonalfinance.com.
00:14:21.120 | We're going to have a special celebratory episode for episode 500.
00:14:26.080 | If you'd like to contribute your voice to that, I would love it if you would do that.
00:14:30.120 | All you need to do is just simply pull out your phone, record a quick voice memo and
00:14:34.080 | send that to me at Joshua@radicalpersonalfinance.com.
00:14:37.320 | Specifically just tell me how the show has impacted you.
00:14:41.040 | Tell your other listeners how the show has impacted you and what progress you've made
00:14:44.640 | in the last few years of listening to Radical Personal Finance.
00:14:47.520 | Please try to keep that to about two to three minutes so we don't bore your fellow listeners
00:14:51.840 | insufferably and that'll be greatly appreciated.
00:14:54.320 | Two to three minutes would be perfect.
00:14:56.040 | While you're at that, please send me, if you would like to, feel free to send me a picture
00:15:00.160 | of you and your family.
00:15:01.160 | I've just got that set up on a screensaver on my computer so that way when I'm recording
00:15:05.880 | the show I get to look at all your beautiful family pictures.
00:15:08.440 | I love seeing those.
00:15:09.440 | It helps me to visualize who I'm speaking to each day.
00:15:11.920 | That's so helpful.
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00:15:18.360 | I'll be back with you tomorrow.
00:15:22.040 | Bye.
00:15:31.640 | This show is part of the Radical Life Media network of podcasts and resources.
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