POWER OF COMPOUNDING (POC)

Rule of 72

POWER OF COMPOUNDING (POC)
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Rule of 72
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Rule of 72

Einstein’s Rule of 72 is considered one of the most important investment tools ever formulated. To calculate how soon and/or at what interest rate one’s investment money will double by POC, the Rule of 72 is a simple formula to use.

Table 3

Table 3 shows how to apply the Rule of 72 to calculate the number of years required to double an investment.

72 is the fixed number.

72 is divided by the interest rate.

TO FIND THE NUMBER OF YEARS REQUIRED

FOR AN INVESTMENT TO DOUBLE

72 = Number of Years Required for an Investment to Double
Interest Rate

Question: If an investor earns 8% interest, compounded annually, how many years are required for his/her investment to double?

Answer: To calculate the number of years required for the investment to double, divide 72 by 8. The answer is 9 years.

Table 4

Table 4 shows how to apply the Rule of 72 to calculate the interest rate required to double an investment in a specified number of years.

72 is the fixed number.

72 is divided by the number of years.

TO FIND THE INTEREST RATE REQUIRED

FOR AN INVESTMENT TO DOUBLE

72 = Interest Rate Required to Double an Investment Number of Years in a Specified Number of Years

Question: If an investor wants to double his/her money in 5 years, what interest rate is required?

Answer: To calculate the interest rate required, the investor would divide 72 by 5. The answer is 14.4%

Calculation of Compounding by Rule of 72

Vs.

Actual Value Calculated by Computerized Compound Interest Calculator

Table 5

Table 5 shows the difference in the end values of a one-time investment of $10,000 (in 9-year increments), using the Rule of 72* vs. using a computerized compound interest calculator.** In both examples, the interest rate is 8%, compounded annually, and the duration of the investment is 54 years.

Year

Rule of 72

in $

Computerized Calculations

in $

0

10,000

10,000.00

9

20,000

19,990.05

18

40,000

39,960.19

27

80,000

79,880.61

36

160,000

159,681.72

45

320,000

319,204.49

54

640,000

638,091.26

Note: The values in the above table differ only slightly between the two methods of calculation used. The Rule of 72 is a reliable tool for investment purposes, as long as the interest rate is less than about 20%. At higher interest rates, significant errors occur.

*moneychimp. Rule of 72 calculator. http://www.moneychimp.com/features/rule72.htm

**1728 Software Systems’ Compound Interest Calculator. [Computerized]

http://www.1728.com/compint.htm

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