Wouldn’t it be great to if you could double your money, effortlessly? That could be the objective of many stock market investors because they expect greater rewards from investing in shares. But how long, exactly, will it take to double your money? The secret lies in the “Rule of 72”. This rule of thumb is supposedly attributed to Albert Einstein. Reportedly, Einstein even called the underlying theory behind the “Rule of 72”, namely compounding, the Eighth Wonder. So, what exactly is compounding and why is it wondrous? Compounding is a relatively easy concept to grasp if you…
But how long, exactly, will it take to double your money?
The secret lies in the “Rule of 72”. This rule of thumb is supposedly attributed to Albert Einstein. Reportedly, Einstein even called the underlying theory behind the “Rule of 72”, namely compounding, the Eighth Wonder.
So, what exactly is compounding and why is it wondrous?
Compounding is a relatively easy concept to grasp if you have ever built a snowman. That’s kind of difficult in Singapore but please bear with me while I try to explain.
You first of all start with a ball of snow that you carefully compress in your hand. Then you roll it along the ground, and as the ball rotates, it picks up more snow and grows in size. At first it grows slowly, and then it gets bigger. As the enlarged ball picks up more snow its growth accelerates. In other words, the snowball compounds in size.
In finance, compounding should work in a similar way.
When money is invested properly it should generate a return. Provided those returns are reinvested it should grow. The enlarged pot, like the snowball, should grow slowly at first, but as the investment gets bigger, so too should the returns.
Some types of investments generate higher returns, which should let you to double your money more quickly. And this is where the Rule of 72 comes into its own.
The rule simply states that if you divide 72 by the expected rate of return, the resultant is the number of years it will take to double your money.
For example, if your savings account is paying 2%, it should take you 36 years (or 72 / 2 = 36) for your money to double. If you are only earning 1% on your money then it could take you 72 years.
You can significantly cut the time it takes to double your investment by looking for products that generate better returns. These higher returns could, for instance, be achieved by investing in shares.
Although the Rule of 72 can be useful for working out how long it should take for an investment to double, it is worth bearing in mind that risk and reward go hand in hand.
In other words: the greater the reward, the greater the risk. Consequently, it can be a good idea to have a blend of investments with varying rates of returns in your portfolio.
Professionals call it diversification. I just call it common sense because it never makes sense to put all your eggs in one basket. You may not get the best return but nor will you end up cracking all your eggs if you accidentally drop the basket.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.