Tuesday, February 10, 2009

"Rule of 72"

When it comes to investing & savings, the "Rule of 72" is the gold standard. It simply states how long it will take for your money to double at a given rate of interest. The true benefit of this concept is derived from retirement accounts (i.e. Traditional & Roth IRA, 401k, 403B) as opposed to everyday or non-qualified accounts.

Let's look at a few examples:

What the above fails to indicate is with higher returns comes higher volatility (aka 'risk'). Growth mutual funds can have wild fluctuations while CD's offer stability. However, the lower the volatility, the lower your annual returns.

For example, if you start with $10,000 and desire a $20,000 ending balance in 10 years, you're going to have to strive for a 7.2% annualized return. Simply choosing a 2% CD will not get you to your goal. Balancing risk & reward is key.

Recent years have many raising an eyebrow as to the validity of this concept. 2008 was a dismal year for the stock market and essentially erased 5 years of gains. However, averages do play out over time and things will eventually revert back to the mean. If your time horizon is long enough you should see the "Rule of 72" work in your favor.

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