Saving & Investing - Head Matters

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3. How Interest is Earned

c. Rule of 72

The Rule of 72 is a simple way to illustrate the magic of compound interest, it shows how compound interest doubles savings faster than simple interest.  You can use the rule of 72 to figure out how long it will take to double your money based on your interest rate, which is also called the rate of return on your investment.

Here's how it works – just divide 72 by the interest rate you expect to earn on your investment. Remember, this calculation assumes that you will leave all of the earned interest in the investment.

72 divided by the rate of interest being paid = the number of years it will take for your money to double when interest is compounded.


So, given the rule of 72, how long will it take an investment to double if it has a 10% interest rate and the interest is compounded?

72 / 10 = 7.2 years

It will take an investment with compound interest at 10 percent 7.2 years to double.

Let’s take another look at that $100 initial investment:
 

 Year Simple Interest Adds Total Saving Simple Interest Compound Interest Adds  Total Saving Using Compound Interest 
1 $10  $110 $10 $110
2 $10  $120 $11 $121 
3 $10 $130 $12 $133
4 $10 $140 $13  $146
5 $10  $150 $15 $161
6 $10  $160 $16  $177
7 $10 $170 $18 $195
8 $10 $180 $19 $214

 

As you can see, at a little over 7 years the initial investment of $100 doubles to $200. If you look at the simple interest columns you'll see that it would take 10 years for the money to double if you took out the interest earned each year.


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