Albert Einstein once described that the compounding effect of an interest rate is the 9th WONDER OF THE WORLD. He could not be exactly wrong about it!
Let's see how you can apply THE RULE OF 72 in your everyday life.
Assume that you have currently RM 60000 and you need raise it up to RM 120000 in an investment product that gives you 7% return per annum (compounded). Just how long do you think you need to wait to achieve that RM 120000?
To get the solution, you just need to divide 72 by the return rate.
(72/ 7%) = 10.2 years
Which means, you need to wait 10.2 years to see your capital grow to double the amount.
Assume that you presently have RM 5000 cash in hand and your father had asked you to safe it in a fixed income security that generates 3.5% per annum. You aspire to use that money in the next 6 years time to cover the down-payment proceeds of RM 30000 ( You plan to purchase a new residential house in 6 years from now and its down-payment is RM 30000).
By using RULE OF 72 method, (72/3.5%) = 20.5 years, which means your current money of RM 5000 will be raised to RM 10000 in the next 20.5 years if you follow the advise of your father by investing in an investment product @ 3.5% per annum return.
If you need RM 30000 in 6 years time, you need to currently have RM 15000 at least, and invest in an investment product that can generate a return of 12% a year.
(72/12%)= 6 years
Under this circumstance, you would probably discard your wish to purchase that dream house of yours unless someone is willing to top up your RM 5000 to RM 15000. Good Luck!
The RULE OF 72 can be used to find the required number of years for a money to double as shown in the first example above. Also, the rule can be used to find the rate of return required to see your money to double, as shown in the second example above.
Remember, this method does not work on a simple interest rate scenario. It only functions when the rate of return is a compounded type.
