So you want to get rich? There’s few ways that the average person can become rich. One way is to win the lotto. Another, more practical and realistic way, is to learn the rule of 72 formula and how it can bring you wealth.
Don’t take my word for it. Albert Einstein, one of the greatest minds of our time, often talked about compounding interest as the 8th wonder of the world. Compounding interest is the fuel that makes the rule of 72 formula work.
What’s the big deal about compounding interest? For the uninitiated, let me explain the magical power behind it.
If you look at the world around you, really everything works on the principle of compounding. All compounding boils down to is growth upon growth. It’s also known as exponential growth, and it’s what makes big things.
A popular law that depends on exponential growth is Moore’s law, for you science geeks out there. The law states that the number of transistors on a silicon chip doubles every 2 years. For you non-nerds, that means that technology gets exponentially better every 2 years. Which is exactly how we were able to invent the PC and then put that same computing power in a cell phone just a decade later.
But it doesn’t just apply to technology. Exponential growth is how viruses spread. A single germ cell infects another, and then those two infect two more. Before you know it, everyone in my house is sick and I always get the worst of it.
When you accelerate in a car, it takes a ton of force from the engine. However, as you gain speed, it becomes easier and easier to gain more speed. It compounds.
Or look at a tree. Notice how the branches spread out from other branches, and same with the roots. A baby tree that was planted years ago continues to grow over the decades, by growing on its growth.
The most wide known example of compounding interest is how it is just like pushing a snowball down a hill. The initial effort is difficult, but as the snowball gains mass it picks up more and more snow until it is so big it rolls on its own.
You can have this phenomenon happen with your money.
Compounding Interest Example
The power of compounding interest is astonishing. Consider this example that clearly shows how anyone with an average income can become a millionaire over time.
Take the median income in the United States, $50,000 a year. If a person with the median income were to save 10% over 40 years, or $5,000 a year ($416.67 a month), they would end up with $200,000. Not too shabby, but not exactly filthy rich.
Take that same person, and assume instead of saving that money, they invested that money and earned an average of 10% a year. At the end of the 40 year period, that person would have a ridiculous $2,434,280!
Do you see why compounding interest is powerful?
When money you make is making you more money, it’s like you are building an empire and every dollar you own is your worker bee. Except, with compounding interest, each worker bee is actively recruiting you more worker bees. In time, the growth your empire would experience becomes exponential… and like in the example a few hundred dollars could become millions.
How cool would it be to have your money diligently working for you, 24 hours a day? This is what can happen when you apply the rule of 72 formula and set aside some money for investing. Let me tell you something, the outside air smells fresher when the buzzing businesses around you are all working hard to build YOUR empire.
Now, the rule of 72 formula is a quick way to assess how much a certain investment can help you. Planning your investments requires knowing what to expect, and if you have no clue about what kind of returns to expect from different asset classes be sure to read the piece I did about average return on investment (ROI).
What the rule of 72 formula does is tell us how fast our investment will double depending on the return % or interest rate. Once we know this number, we can extrapolate our results into the future to see how long it will take us to reach our investing goals.
The rule of 72 formula is simply this:
[72 / (Interest Rate) ] = # of years
Take the previous example from above again. Remember that we said the investor was making 10% a year. So if you plug in 10 to the equation above, you’ll get 72 / 10 = 7.2 years.
This is cool because it gives investors a very specific time frame on when they can expect to double their money. If I know that I am investing for a very long time period, such as a lifetime, that I can reasonably expect that money will double many times over.
As it keeps doubling, you can imagine how big the numbers get!
This is how the snowball metaphor, the exponential growth, compounding interest, and the rule of 72 all fit together. A perspective like this one makes you happier as you grow older instead of sadder.
If you are going to play this game it’s best you start now. The longer you wait to start pushing that snowball the less time you will have to enjoy the benefits! Why wait extra years for your money to start doubling? Why not start now?
Have you heard of the doubling penny story? In essence, it looks at how much money you would have if your money doubled every day.
Let’s say you started with a penny. At day 2, you’d have 2 pennies, at day 3 you’d have 4, and on and on. By day 18, you’d have $1,000. And by day 31, you’d have $10 million.
Now we all aren’t starting at one penny, and we aren’t doubling our money everyday, but I hope you can really see the power behind compounding. With the rule of 72, and with average US life expectancy, you could double your money 11 times over a lifetime (with just average 10% returns!).
What happens when just $1,000 is doubled 11 times? It becomes over $2 million! Again these numbers are all conservative! Your results could be much greater!
So don’t delay. Start now.
You can make small money become large, if you just have the patience.