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The Rule of 72

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I love learning new tricks!

Last week I learned about the rule of 72.  I had never even heard the term before, never mind how it works.

Plus, it has to do with finances and investments which are my two favorite topics.  Yup, sports definitely takes a back seat with me.

I am sure there are a few people that know the ins and outs of this, but for anyone that has never known about the rule of 72 here is how it works. (here is a much more detailed explanation from wikipedia, if you are interested)

First for the fun side of it.

It is a quick and easy way to tell you how long it will take a particular investment to double, if continually reinvested with compound interest.

I think that is simple enough but here is an example:

If I bought a term deposit and I expect a 5% return (ouch! returns that low hurt) on that money I would divide 5 into 72.  Doing the quick math this tells me that the money will double in about 14.5 years.

Pretty cool right?

For me it is really nice to get an idea of exactly how quickly my money is working for me.

Just think if you can secure an 8% return you can double your money in just (72 / 8 = 9) 9 years.  Now, when I am at the bank looking at under performing mutual funds, I can see a more detailed picture of the impact it has on me.

OK that side of the rule is great.  But here is the downside.....the same rule works in reverse.

So with all the talk about rising inflation we can use the same principle to see how long it take for our money to lose half it's value (Inflation will cause prices to go up which will decrease the amount $1 can buy).

Are you ready for this?

The Bank of Canada tries to keep inflation around 2%.  If we take that number and divide it into 72 our spending dollar loses half its value in 36 years.

But many economists fear high inflation for the near term future.  Canada's inflation rate for July was 3.4%.  At this rate our dollar is cut in half every 21 years.  That's a 15 year difference!!

Does all this math mean anything to the average person?  Unfortunately, most people won't think any more of it than a 'neat trick'.  But there is one more thing to think about, and I will use myself as an example.

Let's guess that inflation will average close to the Bank of Canada target for the next 30 years.  At that time I would be 60 years old.

Maybe I want to retire at that age (although I hope to have more on the go than ever), and I set up my retirement plan to live off $50 000 a year when I retire.  I figure I can live decently off that given my current setup.

Except I forgot to factor in inflation.  At a rate of 2.5% my $50 000 today would be worth just under $25 000.

Now I don't know about then but even in today's dollars $25 000 doesn't go very far.

WOW, that's an eye opener.  I'll end this post there as I have to go look for some high performing investments to get this rule working in my favour!

I hope you find the same.

- Nick Karadza

p.s.  Remember, if you're looking for Real Estate Investing information, tips and guides straight from two Canadian brothers who work with Canadian Real Estate Investors investing in their own backyard sign up for the Renegade News Letter by clicking here!

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