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Missed Fortune – Using the Rule of 72 to Prepare For the Future

Posted on | February 24, 2014

A Simple Rule

A little math can go a long way in preparing for your future. Each of us hopes to have a life of abundance where we are capable of taking care of our needs while providing for meaningful experiences.

This means more than simply preparing for a comfortable retirement. It means having the ability to help family, friends, and worthwhile charities along the way. One of the ways that we go about accumulating wealth involves doubling our money.

This is where it is essential to understand the Rule of 72.

The Rule of 72 says that you take whatever interest rate you might be earning on your money and you divide that into the number 72. The answer will tell you how many years it would take to double your money.

For instance, let’s say you were earning 8% interest. 72 divided by 8 is 9. This means that at an 8% interest rate, your money would double every 9 years. If you were earning 9%, your money would double every 8 years. And so on.

The reciprocal of this equation is also true. If you look at how many years it takes to double your money, and divide that into 72, you’ll discover the compounded interest equivalent or appreciation rate required to double your money.

The rule of 72 can be a handy tool in helping determine which investment strategies will help double your wealth. But there are other considerations that are crucial to understand.

Inflation Versus Your Money

When it comes to accumulating financial wealth, you need to know how much today’s dollars will buy down the road. This is essential to know because that’s when you’re going to need those dollars the most.

Let’s say that your 65 years old and, with a bit of belt-tightening, you determine that you can live on an income of $3,000 per month. This is what you’ll be spending on gas, groceries, prescription medications, golf green fees, etc.

Now, let’s say that inflation is averaging 5% a year. How much would you need 30 years down the road? Remember, life expectancy is still on the increase. So living into our 90s is a definite possibility.

To learn how inflation would affect the purchasing power of your money in the next 30 years, you would divide 5% inflation into 72. The answer will show that the costs of living will double every 14.4 years. For simplicity’s sake we’ll round that to every 15 years.

When we crunch the numbers, we find that the cost of living will have double twice during that 30-year period. That means that if you’re able to live on $3,000 a month now, you’ll need $6,000 a month to buy those same gas, groceries, prescriptions, and golf fees in another 15 years.

By the time you hit age 95, the cost of living will have double once again, meaning you’ll need $12,000 a month to purchase the same things that would cost you $3,000 a month today.

What if inflation were to jump to 10% like it did during the early 80s? You’d need that $12,000 a month in just 15 years to buy what you could for $3,000 today.

The bottom line is that preparing for the future isn’t quite as simple as many people think. Without taking a good look at the effects of inflation and using the rule of 72, many people are caught off guard.

It’s one thing to be surprised, it’s another to be stunned by reality when you discover, mid-retirement, that your money isn’t enough to last.

This is a rude awakening that will happen to those who have kept their retirement savings in tax-deferred accounts like IRAs and 401(k)s. Taxes will eat up a big chunk of those savings and inflation will whittle down the purchasing power of each dollar unless you’ve planned ahead.

What if, instead, your money was accumulating in a tax-free vehicle? What if your gains were tied to those things that inflate so times of inflation help you rather than hurt you?

What if your money was indexed in such a way that you didn’t lose money when the market declined and you made money whenever the market grew?

If you’re ready to learn these strategies and more, visit with a wealth architect today.

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*Life insurance policies are not investments and, accordingly, should not be purchased as an investment

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