The rule of 72: small sums can make a big difference

This handy shortcut lets you quickly judge the impact of different growth and inflation rates. Here’s how it works.

The rule of 72

The rule of 72

0:10welcome to this killing explains finance video this week the rule of 72 or how
0:18small sums can make a big difference now remember something I’ve covered before
0:22another videos
0:24the awesome power of compounding you have a friend when it comes to long-term
0:28investing you are many people who have won call compounding and supposedly
0:32albert Einstein no less call it the eighth wonder of the world is the
0:36ability to make money on money and is at the heart of what about say next
0:41now the rule of 72 is a really convenient back of an envelope shortcut
0:46to explain how fast you’re going to double your money without loss of
0:50complex mass it was dreamed up by somebody who probably should have got
0:55more often but is very useful and it basically says if you want to know the
0:59answer the question how long will it take me to double my money to get an
1:02annual growth rate it gives you the answer without having to go to a
1:07spreadsheet user complex calculator using mathematical formulae it’s pretty
1:11handy in other words if you divide 72 and rule of 72 by the growth rate you’ve
1:18got in mind you get an approximate estimate of how long it will take you to
1:22double your money so how does that work some quick look now it works really well
1:27in a certain range of interest rates in terms of accuracy in about five in about
1:3212 percent Its a really handy rule of thumb and it can be adjusted the numbers
1:36outside that range I’ll leave that beyond the scope of this current video
1:40says look at three right we’re going to work quite well
1:4210% 8% 6% these are not guaranteed
1:46just as illustrations now how long will it take me to double my money that takes
1:51a bit of fiddling around with a calculator spreadsheet or proper formula
1:55rule of 72 just says divide 72 by that number and you get about seven years
2:01there’s your answer at eight percent seventy 2/8 is around nine years to
2:07double your money remember seventy 2/6 is the power of compounding earning six
2:13percent 6% 6% each year and it took about twelve years
2:17double the original song that’s pretty need now how accurate is it well just a
2:22that after a quick proper calculation if you like using a problem compounding
2:27calculator and what you find is if you apply 6% to rate to an original number
2:34one hundred pounds so up to one year ago hundred pounds plus six pounds then you
2:39take the hundred and 66 percent on top of your hundred and twelve hundred and
2:43twelve and sixteen on top and so on
2:45you get to a point you double your money after around 12 years 201 pounds not
2:51exactly 200 pounds but near enough to those yet rule of 72 demonstrated to
2:56work if you like at a rate of 8% I suggest on the previous slide around
3:03nine years using the rule of 72 exactly how much bang on their two hundred
3:07pounds you know the compounding calculator with a rounding and a 10%
3:11well no but after seven years yet with around a hundred and ninety five pounds
3:18so the true answer is more like seven point two years you get the idea
3:23the back of an envelope way of calculating how long it take double your
3:26money pretty handy now that you can reverse it you could also say alright if
3:32I assume asset inflation right how long will it take to haul my money at those
3:37inflation rates inflation rate of 10% we have had that in the UK in the past
3:42albeit not now the rule of 72 is about seven years
3:45same principle 72 divided by the number give you the answer at eight percent
3:50about nine years and six percent about 12 years so it can be turned on its head
3:55and used like that and that’s interesting for investors when you look
3:59at what I’ve called before the problem with cash and the problem with cash is
4:04that in real terms it is basically a road in your ability to buy stuff is
4:09only viewable seen this child before we go back to the early seventies alright
4:13and look at the purchase purchasing power 100 pounds but it didn’t take long
4:17to have that when inflation was much higher than it is now
4:22family is handy to tell you how long and now you’re right down to more like four
4:29to six or seven
4:30money’s worth purchasing power pretty bad news so it’s turned on its head and
4:34look at something more positive and it’s basically days we should all be siding
4:39and if we’re not gonna saving cash where do you wanna be saving well somewhere
4:43else so how we gonna save more than where we gonna save it
4:47well here are some suggestions about around my life the moment only know
4:51handle their ways I can save money on travel and every little bit helps I
4:56could be clever away I use my card for example I can save money on things like
5:01my cable TV channels I can save money on bills by shop around a bit more
5:05regularly but more often and i cant even shave it off my mortgage in let’s say I
5:10sit down and actually do that one day and come up with the idea I could save
5:14then easily hollywood that we are without noticing an extra fifty pounds a
5:19month why am I gonna do with it
5:21probably getting your idea of this not putting cash to invest it in something
5:28wet my pussy power won’t be around hopefully like shares let’s run a few
5:33scenarios just have any shelf so imagine imagine i kidded 2% over 25 years as a
5:39pretty conservative estimate remember it’s fifty pounds a month I’m saving the
5:44under 25 years that’s a fairly tidy sum of twenty thousand pounds twenty
5:48thousand pounds it meaningful some and I’ve got it by just squirreling away an
5:52extra fifty pounds and I hardly noticed where I had to cut costs in order to get
5:56that 50 pounds 2 percent isn’t very exciting imagine I couldn’t 5 percent
6:02instead no guaranteed
6:04imagine I could do that UK’s long-term returns from shares of the last 50 years
6:10with such evil is out there certainly are safe 30,000 pounds just attacking 50
6:15pounds away every month and it a little bit aggressive about it I could get 8%
6:20not crazy about Google 8% then suddenly my becomes 48,000 pounds
6:27five years so there you can see how small amounts to make eventually a big
6:32difference if you let compounding work for you lots covered there you’d like to
6:37know more about the rule of 72 when it works when it doesn’t like nothing else