Use the Rule of 72 to sort the facts

A COUPLE of months ago I wrote about the Rule of 72 and pointed out that it was a wonderfully simple tool which can be used in many circumstances.

Just to refresh your memory it is an easy way to do compound interest calculations in your head.

The best part is that you don’t have to be a mathematician to use the Rule of 72.

It’s simple, but once you understand how to use it, you’ll wonder how you got by without it.

It works like this – divide the number 72 by the expected rate of return – the answer is the number of years it will take for a given sum to double at the expected compound rate of return.

Alternatively, divide 72 by the time frame in years and this will give you the forecast percentage return.

Suppose your home is worth $400,000 today and you predict it will increase by 7 per cent a year. Divide 72/7 per cent and the answer is close to 10.

If your prediction is correct, your house will be worth around $800,000 in 10 years, and $1.6 million in 20 years. Last week I used it.

I was driving in the car listening to the radio and suddenly a scary story came on predicting that water prices would, shock, horror, “double in 30 years”.

This was followed by the usual comments from experts about water prices in general and about how terrible this would be if the forecast increases occurred.

Well, if we go back to our Rule of 72, and simply divide 72 by 30 we get an answer of 2.4 per cent per year. In other words, we could change the statement to “over the next 30 years water prices are forecast to rise by around 2.4% which is about the rate of inflation”. I would say that’s perfectly normal.

We are now bombarded on a daily basis by all sorts of outrageous statements.

The trick is to be able to sort out the rubbish and make decisions based on fact not fiction.

It works like this – divide the number 72 by the expected rate of return – the answer is the number of years it will take for a given sum to double at the expected compound rate of return.

Noel Whittaker is the author of Making Money Made Simple. His advice is general and readers should seek their own professional advice before making any financial decisions. Email: noel@noelwhittaker.com.au