Monday, July 9, 2007

What banks won't tell you 3 x 3

The Rule of 72, which tells you how long it takes to double your money. 72/[return rate you’re getting] = # of years to double your money. For example, if you’re getting a 10% interest rate from an index fund, it would take you approximately 7 years (72/10) to double your money. In other words, if you invested $5,000 today, let it sit there, and earned a 10% return, you’d have $10,000 in about 7 years. And it doubles from there, too. Of course, you could have even more by adding a small amount every month using the power of compounding.
To give you an example of how much money that would be, for example, one of my kids will probably have a baby in the next couple of years. I was thinking I might put away $1,000 as a gift in an index fund. Let’s just assume it earns 10% annualized during the grandchild’s life. Guess how much it would be worth at age 63?
Age 1: $1,000
Age 7: $2,000
Age 14: $4,000
Age 21: $8,000
Age 28: $16,000
Age 35: $32,000
Age 42: $64,000
Age 49: $128,000
Age 56: $256,000
Age 63: $512,000
Basically you can see that my grandchild would be rolling hard thanks to Grandfather Rev.’s $1,000 gift 63 years prior.
And it grows from there–note how fast the money grows towards the end. Yes, this is a simplistic model that assumes a 10% return rate and yes, it leaves out inflation/taxes. But it shows you how much a $1,000 investment can grow with time–even though you didn’t add an extra dollar to it. The critical factors are time, minimizing fees/taxes, and picking sensible, long-term investments. What are you going to do today?

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