Revisiting the Rule of 72: The Power of Compound Interest Over Time

The rule of 72 is such a powerful concept that I wanted to readdress it; I wrote about it back in 2011 in a post titled, "The Rule of 72 - The Real 8th Wonder of the World."

As I explained in that post, the rule of 72 is a quick way to calculate the length of time it will take your money to double given a certain interest rate. As a recap, here's how it works:

What I'd like to emphasize in this post is that the takeaway concept is not the calculation itself, but the power of compound interest over time. Time is on our side when it comes to savings and investing. Every dollar you save now will have a much greater impact on your financial success than a dollar saved in one or ten years from now. Sure, there is no guarantee you will receive positive returns on your investments, but even assuming a conservative return demonstrates that saving and investing now has a greater impact on accomplishing long term goals than saving later.

Here are a few examples--each assumes a 4.5 percent return (only 1 percent higher than historic inflation). In the first example you put $1,000 away each year starting now for 25 years. In example two, you put $1,000 away per month starting in 10 years for 15 years. At the end of the 25 year period you have totals of $44,565 vs. $20,784. Of course, in real life there would be taxes and fees that we would have to consider, but there is still a striking difference between the two totals. More than twice the funds if you started now!

In the third example, you contribute $1,666 per year starting in ten years for 15 years. This is the same total amount contributed as the first example ($25,000). However, because the same funds had less time to grow the total is only $34,626. Simply by starting to save now, you will have an additional $10,000. If you wait, that is $10,000 of additional retirement savings that won't materialize because time and compound interest weren't on your side. Think of how much time it takes to earn $10,000. In example one, in which you start saving now, your money is indeed working for you.

How can you make compound interest work for you? Start contributing today towards your long-term goals, which will happen more than 10 years from now. You can use the Rule of 72 as a quick way to calculate how your money can grow. Small savings, incremental and consistent, can have a powerful impact. Set up automatic deposits from each paycheck. Then make sure those funds are invested according to your goals and risk tolerance. I help clients assess which investments are most appropriate for them. If you have investment questions, please contact me for a free consultation. Putting a long-term strategy in place will help you SaveUp over time!

This post was written by SaveUp's personal finance contributing writer, Catherine Hawley, CFP.