The lessons to be learned from knowing and applying the Rule of 72 should be taught in schools, but they aren't.
So let's do it here as part of an ongoing effort to spread the word about a lifetime of better managing our personal debt levels, savings and investments in a responsible and highly profitable manner. The earlier we let the power of compound interest and its relationship to time go to work for us, the greater the likelihood we will avoid personal financial problems later in life. So here goes.
Learning the Rule of 72 is a simple yet profound way of internalizing and understanding how time and compound interest work to the benefit of the individual saver and investor. And if adopted and then followed consistently over a long period of time, the impossible becomes the inevitable for individuals who are not generally knowledgeable about financial matters.
How a 1% savings boost could sweeten your retirement has the story about the 'magic' of compound interest:
"When it comes to saving for retirement, what difference can another 1% of your pay make?
Thanks to the magic of compounding, “a little bit (of extra savings) today can go a long way tomorrow” in terms of the retirement income it’ll generate, says Fidelity Investments, which crunched the numbers for a report released this week.
According to Fidelity’s calculations, a 25-year-old with a $40,000 salary must set aside an additional $33 a month to save an extra 1% annually. But that little bit of extra savings will translate into an additional $320 of monthly income (in today’s dollars) over a 25-year retirement. (This assumes our 25-year-old earns a 1.5% annual raise, net of inflation, works until he is 67, and earns a 7% annual return.)
According to Fidelity:
- A 35-year-old with a $60,000 salary who saves an extra 1% annually must save $50 more a month now, but will receive an additional $270 of monthly retirement income in today’s dollars.
- A 45-year-old with a $70,000 salary who saves an extra 1% annually must save $58 more a month now, but will receive an additional $160 of monthly retirement income in today’s dollars.
- A 55-year-old with an $80,000 salary who saves an extra 1% annually must save $67 more a month now, but will receive an additional $70 of monthly retirement income in today’s dollars.
“When you ask people, ‘Can you save more?’ many people think, ‘I can’t,’” says Jeanne Thompson, a vice president at Fidelity. That’s because they “assume that they have to save so much more and a little bit isn’t going to make a difference.” But the key insight, she adds, is that “little incremental differences can make a huge difference over time.”
According to Fidelity, many people underestimate the impact saving 1% more can make. When asked how much an extra $50 a month would amount to over a 25-year period, the median response was $17,000—or less than half the $44,000 value Fidelity projects.
Fidelity recommends putting away 10% to 15% of annual pretax pay for retirement, including matching contributions from an employer. “But if you don’t save this much from the get-go,” don’t despair, the company says. “Start by saving up to the company match,” says Thompson and then increase your savings rate by 1% every year until you hit the 10% to 15% target.
More potentially good news: When told the benefit of saving 1% more, almost 90% of the 1,039 people who responded to a poll Fidelity conducted said it would either be an “extremely easy” or “easy” thing to accomplish."
Spread the word.
Better yet, save another few percentage points each pay period, invest in stocks and watch the power of the Rule of 72 deliver its 'magic' for you.
Long term it's a no brainer.
That's my take.