How can compound interest be the eighth wonder of the world?
Gather round my friends, I’m about to share with you the little secret of how the rich get richer and the poor stay poor.
Oh, and also a great way to wow your friends at cocktail parties.
It’s called the “Rule of 72.”
I know, sounds boring. But when you see its power it’s pretty cool.
Let’s say you’re 25. You have $20,000 saved. You invest it and average 10% per year, the long term average of the stock market.
The “Rule of 72” says divide 72 by your percentage return. This tells you how many years it takes for your investment to double.
So, in this case, every 7.2 years. Let’s round it off to 7.
So at 32 years old it grows to $40,000. At 39, $80,000. At 46, $160,000. At 53, $320,000. At 60, $640,000. And at 67, $1,200,000. Shazzam! You’re a millionaire.
Or you could have spent the $20,000 on a new BMW and said, “I’ll start saving later.” If you started at 32 you’d have $640,000 at 67 rather than be a millionaire.
Oh, and the BMW long ago gone went to the scrap yard.
Second scenario, same starting point.
You want to be really safe. So you put your $20,000 in the bank. Guaranteed. Insured. Returning say 3%. Not bad.
The “Rule of 72” says your investment will double in value every 24 years. 72 divided by 3.
So now at 49 it’s worth $40,000. And at 73, $80,000.
So though the rate of return was about a third, your total return was only a fraction.
That, my friends, is the eighth wonder of the world. Compounding returns.
And the “Rule of 72”. A cool little tool to calculate how rich you can grow.
And wow your friends over cocktails.
The poor focus only on saving. The rich focus on compounding.
How can compound interest be the eighth wonder of the world?
Gather round my friends, I’m about to share with you the little secret of how the rich get richer and the poor stay poor.
Oh, and also a great way to wow your friends at cocktail parties.
It’s called the “Rule of 72.”
I know, sounds boring. But when you see its power it’s pretty cool.
Let’s say you’re 25. You have $20,000 saved. You invest it and average 10% per year, the long term average of the stock market.
The “Rule of 72” says divide 72 by your percentage return. This tells you how many years it takes for your investment to double.
So, in this case, every 7.2 years. Let’s round it off to 7.
So at 32 years old it grows to $40,000. At 39, $80,000. At 46, $160,000. At 53, $320,000. At 60, $640,000. And at 67, $1,200,000. Shazzam! You’re a millionaire.
Or you could have spent the $20,000 on a new BMW and said, “I’ll start saving later.” If you started at 32 you’d have $640,000 at 67 rather than be a millionaire.
Oh, and the BMW long ago gone went to the scrap yard.
Second scenario, same starting point.
You want to be really safe. So you put your $20,000 in the bank. Guaranteed. Insured. Returning say 3%. Not bad.
The “Rule of 72” says your investment will double in value every 24 years. 72 divided by 3.
So now at 49 it’s worth $40,000. And at 73, $80,000.
So though the rate of return was about a third, your total return was only a fraction.
That, my friends, is the eighth wonder of the world. Compounding returns.
And the “Rule of 72”. A cool little tool to calculate how rich you can grow.
And wow your friends over cocktails.
The poor focus only on saving. The rich focus on compounding.
Gather ’round my poor audience. I’m about to share with you the little secret of how the poor stay poor.
It’s called, “Nothing times nothing leaves nothing!” Let me know how that works out.
Compounding is the absolute magic that every person in the school should be taught. And it’s often told as, “put $100 a week aside for investment”. Most struggling people will balk at this, since it is certainly unrealistic for many of them. Well then, I’d say, put $50 aside. Or $25 aside. At retirement, you’ll be WAY ahead of where you would be otherwise.
I also tell people sometimes that “a penny saved is TWO pennies earned”. Saving is exactly the same as earning, and if invested, allows your money to work on itself.
However, that said, someone who cannot earn a living wage is stuck in a cycle of poverty. So, let’s be clear that it’s this which is the dynamic to blame!
Now, on the other hand, a wealthy person who doesn’t get wealthier is truly at fault.
As a financial planner to further demonstrate compounding I would ask clients how much do you think you would have if you took one penny and simply doubled it every day for 31 days. The guesses would be in the range of less than a hundred dollars to a few hundred dollars. When I revealed the amount they tended not to believe that one penny could compound to $10,737,418.24. The point is that time was the factor, if seen on a graph it all tends to happen in the last days.
Exactly. And a great illustration my dad taught me when I was young.
Long-term compounding is the best friend of the investor and the worst enemy of the debtor. The average person can retire rich if they understand only this ONE principle.
How can compound interest be the eighth wonder of the world?
Gather round my friends, I’m about to share with you the little secret of how the rich get richer and the poor stay poor.
Oh, and also a great way to wow your friends at cocktail parties.
It’s called the “Rule of 72.”
I know, sounds boring. But when you see its power it’s pretty cool.
Let’s say you’re 25. You have $20,000 saved. You invest it and average 10% per year, the long term average of the stock market.
The “Rule of 72” says divide 72 by your percentage return. This tells you how many years it takes for your investment to double.
So, in this case, every 7.2 years. Let’s round it off to 7.
So at 32 years old it grows to $40,000. At 39, $80,000. At 46, $160,000. At 53, $320,000. At 60, $640,000. And at 67, $1,200,000. Shazzam! You’re a millionaire.
Or you could have spent the $20,000 on a new BMW and said, “I’ll start saving later.” If you started at 32 you’d have $640,000 at 67 rather than be a millionaire.
Oh, and the BMW long ago gone went to the scrap yard.
Second scenario, same starting point.
You want to be really safe. So you put your $20,000 in the bank. Guaranteed. Insured. Returning say 3%. Not bad.
The “Rule of 72” says your investment will double in value every 24 years. 72 divided by 3.
So now at 49 it’s worth $40,000. And at 73, $80,000.
So though the rate of return was about a third, your total return was only a fraction.
That, my friends, is the eighth wonder of the world. Compounding returns.
And the “Rule of 72”. A cool little tool to calculate how rich you can grow.
And wow your friends over cocktails.
The poor focus only on saving. The rich focus on compounding.
Gather ’round Mr. Armey. I’m about to share with you the little secret of how the poor stay poor.
It’s called, “Nothing times nothing leaves nothing!” Let me know how that works out.
Compounding IS the absolute magic that every person in the U.S. should be taught. And it’s often told as, “put $100 a week aside for investment”. Most struggling people will balk at this, since it is certainly unrealistic for many of them. Well then, I’d say, put $50 aside. Or $25 aside. At retirement, you’ll be WAY ahead of where you would be otherwise.
I also tell people sometimes that “a penny saved is TWO pennies earned”. Saving is exactly the same as earning, and if invested, allows your money to work on itself.
However, that said, someone who cannot earn a living wage is stuck in a cycle of poverty. So, let’s be clear that it’s this which is the dynamic to blame!
Now, on the other hand, a wealthy person who doesn’t get wealthier is truly at fault.
As a financial planner to further demonstrate compounding I would ask clients how much do you think you would have if you took one penny and simply doubled it every day for 31 days. The guesses would be in the range of less than a hundred dollars to a few hundred dollars. When I revealed the amount they tended not to believe that one penny could compound to $10,737,418.24. The point is that time was the factor, if seen on a graph it all tends to happen in the last days.
Exactly. And a great illustration my dad taught me when I was young.
Long-term compounding is the best friend of the investor and the worst enemy of the debtor. The average person can retire rich if they understand only this ONE principle.
Well stated and so true.
Yeah I always get annoyed when people complain that “the rich just keep getting richer” and complaining about “those evil CEO’s” etc as if they can’t use the same strategies. If you’re at least middle class, anyone can make pretty respectable investments of $10,000+ per year. Sure having a large income is very nice and definitely improves the rate of investments for sure, at least early on the first few years (even if you have a strong enough income to invest $1M a year, there will be a point that this $1M is pocket change compared to the growth per year via interest, especially once you start pushing $100M-$B ranges of total investment). Compounding interest reaches a point where it just grows itself without even needing much actual addition. It’s always nice though at this point to take income and start having fun with perhaps some more speculative stocks. Like Robert Kiyosaki talks about he’s managed to turn $20k into $1M in one year from brand new start up company investments. But, I digress, and anyone can invest. I even proved a few weeks to myself that someone making just $14,000 a year can still invest around $3,000 a year. Sure it would require some really, really frugal living but it can be done. Almost no one is truly unable to invest at all, but sacrifices might be needed to be made, sure. I’m still “relatively” poor compared to where I want to be, but I’m still only 32, and already a net worth of $220,000 or so, with about $130,000 total in stocks (the other $90,000 is from my house. Got a pretty affordable house so a lot of the principal is already paid off and admittedly lucked out that it rose $30,000 in value in just 4 yrs also so that helps too). But, the first $100k in investment is the hardest, so now it’s just a battle of attrition as they say to build up my first $1M and beyond =)
Sounds like you are on the right track. Congrats.
Thanks man. I set a goal for myself to achieve financial independence at around age 40. That’s like the magic number for me because that’s when my house will be paid off and also investments should be high enough to punch the button, if I wanted to. I might not even push the button so to speak, but it’ll be nice to have the option to. I have a fair amount of time to think about it still!
It took most of my life before the number reached anything looking slightly impressive. One day you wake up and think wow how did that happen? I retired at 55 after 28 years with over $1M by doing this.
You decide. And be grateful. Keep calm and stay in joyful.
But the rich are also subject to the high rate of inflation. The dollar is only worth 4 percent of its value since we went off the gold standard in 1913…. Purchased my power also has to be factored in…
Of course.
We didn’t officially leave the gold standard until the 70’s. Ofcourse inflation is compounding also, so you should look adjust the rule of 72 to real growth to figure out how much you have in todays dollars. In the original scenario it was 10%, assume 3% inflation, so 72/(10%-3%) =~ 10 years. In today’s dollars, that’s around $160k at 65 years old (doubled 4 times). This doesn’t seem like much, but it’s 8x where you started without any input from yourself over the years.
Obviously when applying this logic, you can also help yourself with retirement programs which get far more value by reducing/removing tax components, reinvesting dividends automatically (another form of compound growth) etc.
Your math is right on the money (pun intended) - the long term rate of return of the S&P is 10%; when adjusted for inflation it’s 7%.
It’s especially interesting when you consider that the rule of 70 is not a crude approximation, but rather a mathematically reasonable formula (it comes from ln(2)/rate).
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