If you put $10,000 into a savings vehicle that paid 2% annual interest, how long would it take you to double your money?
The intuitive answer would be 50 years: 50 x 2% equals 100% return. But due to the effects of compound interest, you’d actually get there in 36. You’re not just getting interest on the money you originally put in, you’re getting interest on the interest you’ve already earned.
Doubling your money in 36 years is not terribly impressive. But then, 2% is not a terribly impressive rate of return. At 4%, as you might expect, you can double in half the time: a mere 18 years. And in 36 years, you’ll have doubled twice, to quadruple your original money. In 54 years, it will be eight times what it originally was! That sounds like a long time, but if you started saving in your twenties you could reasonably expect to have 50+ years for your earliest savings to compound.
And that’s at a relatively conservative 4% annual return. As your rate of return increases, your compounded returns increase exponentially. At 5%, your money will increase tenfold in 50 years. At 6.5%, your money will increase twentyfold in the same time: a mere 1.5% increase in returns doubled your money over 50 years! It doesn’t take very many doublings to turn modest savings into a sizeable pile of money.
Of course, sometimes this is easier said than done. Returns are never guaranteed and pursuing higher returns generally means accepting more volatility and risk.
The math behind compound interest can be difficult to grasp, but there’s a simple guideline you can use to estimate long term returns known as the Rule of 72. If you take 72 divided by your annual rate of interest, the answer will be (roughly) the number of years it takes for your investment to double. If you divide 72 by 2, for example, you’ll get 36—exactly as stated up above.
If you would like to see how this works with real money, call or email us.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. investing involves risk including loss of principal.