How The Rule of 72 Affects Your Financial Future

[INTRODUCTION] Welcome to “Christian Financial Perspectives”, where you’re invited to gain insight, wisdom and knowledge about how Christians integrate their faith, life and finances with a Biblical Worldview. Here’s your host Christian Investment Advisor, Financial Planner, and Coach, Bob Barber. Bob: Proverbs 21:5, “The plans of the diligent lead to profit, as surely as haste leads to poverty.” Well, hello, Bailey. You ready for an incredible show today? Bailey: I’m excited. Bob: As we were talking about doing this program on the Rule of 72, I think my nerdiness totally came out. Bailey: A little bit, a little bit. Bob: Just slightly. We were like, how can you get so excited about the Rule of 72? Bailey: Yeah. I’ve never seen someone so enthusiastic about math. Bob: Well, I’ll tell ya, you hear me talk a lot on the podcast about understanding how money works and the money game and the Rule of 72. It’s interesting that we’re making a whole, entire program on the Rule of 72. And I remember the first time I heard this was in high school in a math course I was taking on business math and the explanation of the Rule of 72. And it was like a light went on. I was like, wow, this can really be applied towards becoming that millionaire someday. I also heard it again when I started in the financial services business and saw a guy that got a chart and he said the Rule of 72, and he starts doing this math in front of me and in front of the entire audience. I wanted to grab this and really understand how this rule works and investing and making money and having enough money for the rest of your life without running out and how it can apply. I thought let’s bring this to the podcast. Bailey: I’m excited to learn about it. I’d never heard of this before working here, and you’ve been learning about it since high school. We won’t say how long ago that was. Bob: That’s okay. I don’t mind saying I’m 58 years old and hopefully I’ll get to do this another 20 or 25 years. It’s not like I’m out in the fields. I’m here in a nice, comfortable place. And I think I can sit at a desk when I’m 70 years old. And the wisdom that comes from doing this for so many years. I’m going to be the first to raise my hand. Hey, I’ve made a lot of mistakes in life to learn from those mistakes. I want to teach you how to not make those same mistakes. And the Rule of 72, thank goodness, that’s not a mistake I’ve made, but I see a lot of people making mathematical mistakes with their investments by not understanding this Rule of 72. Bailey: Sure, sure. Well, will you tell us what this magic rule is? Bob: Well, if you go look it up on the internet, the Rule of 72 is a simple way to determine how long an investment will take to double giving a fixed annual rate of interest. All right, let’s just think about this. We know right now, the bank is paying about 1%, if you’re lucky, in interest. Whatever you have in that bank, if you just were to let that sit there and didn’t pull anything out at all and if you’re making 1%, by the Rule of 72, it would take 72 years for that money to double if you never touched it. Compounding plays into the Rule of 72. So what I mean is is when you’re making a rate of return, whether you’re making 1%, 5%, or 10%, when you’re applying the Rule of 72, that mathematical formula works when you’re reinvesting the interest that you’re making. So, let’s take a simple amount of money. Let’s take a $10,000 investment. And a simple whole number is 10%. If you were to make 10% on that money in one year, 10% of $10,000 is how much? $1,000. Okay. So it means the next year, so you make that 10% and then by the way, when I’m talking about rate of returns, I’m not going to go beyond 10% or 12% today. I want to make sure that everyone understands when I speak of these rates of returns, these are not guarantees. Nothing is guaranteed in life, except our salvation, but nothing is guaranteed in life. But when I’m talking rate of returns here, I’m going to use some whole numbers like 5% or 6% or 10%, but that’s taking that number and you made money on your $10,000. You made a $1,000, you add it to that $10,000. Now, you have $11,000, and the next year that’s going to make 10%. So that’d be $1,100. And then the next year you’ve got $12,100 making 10%. So, it’s constantly adding that back in and the Rule of 72, when we talk about this, is always compounding. But to understand how this Rule of 72 works can mean the difference between having $500,000 or a million or 2 million. Did you notice I doubled every time there? I went from $500,000 to a million to 2 million. And it’s really important that you understand compound interest or compounding returns and how the Rule of 72 works with it. They go hand in hand with one another. And this is when I was speaking with you earlier today, when I was driving into the office, about how much it can cost you by waiting to save money, because it all is about doubles. It’s all about doubling from a $1 to $2, from $2 to $4, from $4 to $8, from $8 to $16. I’m going to ask you a really simple math question. I know you’re not really a big mathematician. If you have a certain rate of interest, and it’s a trick question I’m going to ask you. How long does it take for a dollar, and you’re making the same rate of interest, for a dollar to double to $2 versus $8 to double to $16? Bailey: The same amount of time. Bob: Exactly the same amount of time. Now, if you go from a $1 to $2 or you go from $8 to $16, have you made more money from the 8 to 16 than the 1 to 1? Bailey: Yeah. Bob: That’s exactly right, but you’re never going to get to the 8 to 16 or the 16 to 32 until you start and get from the 1 to the 2, and the 2 to the 4, and the 4 to the 8, and the 8 to the 16, and so forth. You’ve got to start. So when you look at how much it costs you for procrastinating to start saving, and I was pointing this example out to you this morning, it’s not the first double that’s hurting you. It’s the last double. It’s the double down the line of going from 8 to 16 or 16 to 32. And you look at that last double that you’re not getting for every single year that you wait to save, and it’s costing you hundreds, if not thousands of dollars on a monthly basis because you’re not getting that last double. That last double where it goes from $500,000 to a million or where it goes from a million to 2 million. You think about the last double and you go from $500,000 to a million, and now you’re not going to get to $500,000. It’s going to take you 20 years to get to that point or 25 years saving over and over. But I see this all the time. I have people retiring from the big Fortune 500 companies. They’ve been putting money into their 401k. They walk in with $500,000 to a million dollars, and say I’m retiring. This is what I’m going to retire on. So they’re there, but that last $500,000 double where it goes from 500k to a million, or it goes from 250k to 500k, but we’re going to use the 500k to a million. That’s $500,000. I’m going to divide that. Let’s say you were making an average rate of return of 6%. How many times does 6 go into 72? So get your calculator over there. Bailey: 12. Bob: 12 times. So in 12 years, it would take, at a 6% return, for the $500,000 to double to a million. So, if you take 500,000 and divide it by 12. Okay, I’m doing that on my calculator right here. I’ve got an unfair advantage to those that are listening, but divided by 12, that’s $41,000 every year. You divide that by 12 months in the year. Every month, that’s $3,472. Now, if you wait 12 years to start investing, it’s costing you $3,472 a month by waiting. Bailey: Wow. Bob: Procrastination is the most costly thing out there, and understanding how the Rule of 72 and compounding work hand in hand. If I could just drill it into people your age, Bailey. You’re 26. We were talking about how many doubles that you think you have between 26 and your life expectancy. And you told me, well, I didn’t think I’d make it this far. You know what? I’m at 58. I didn’t think I’d make it this far either. And by the way, you will always hear an older person tell you this. If I’d have known I was going to live this long, I’d have taken better care of myself. But the life expectancy of people today is 80 and 90 years. I mean, our life expectancy has increased dramatically. It used to be 65 years. But even if you make it to 65, and you’re just 26, you’ve got three or four doubles depending on your rate of return between now and then. But every year you wait, you’re not going to have that last double. Bailey: Wow. That’s amazing. That’s amazing. I think for people my age, I know for me, it feels like we have forever to think about things like that. We have so much time before we retire so we can wait, right. But that puts things in perspective very differently. Bob: Yeah. Cause it’s the last double that matters. It’s not the first one. And this Rule of 72 can be applied not only to investing and saving, but it can also be applied to withdrawals. You remember the example I was giving you this morning? What was that example? Bailey: About buying a car? Bob: Yeah. Bailey: And how much that can cost you. Bob: Well, so let’s use the Rule of 72. Let’s say somebody is taking out, and we’re going to use the 6% example. Again, remember, that’s not a guarantee, but if we look at past performance, which is no guarantee of future performance. If we look at past performance, a moderate portfolio average is 5% to 6% a year. So let’s just use 6%, and that’s in a very diversified portfolio of stocks and bonds and cash and maybe gold or silver, real estate, et cetera. So let’s start with somebody that has a $100,000 portfolio, Bailey. An example I was giving you this morning was a $30,000 car because cars are quite expensive today. They don’t have cash reserves. They want to buy this nice, shiny new car. It’s $30,000. By the way, I guess, good luck with that. A lot of them are even more expensive than that today. So, it’s $30,000. They’re going to withdraw $30,000 from their $100,000 portfolio that is in a moderate portfolio making a 5% to 6% average return. Now, I’ve got to say again, that’s not guaranteed, but that’s what our average has been, and that’s what an average balanced portfolio is. You can go to any online brokerage firm or any online mutual fund that’s a balanced fund. You’re going to see that’s kind of the average rate of return. So what happens Bailey, if you would draw $30,000 from a $100,000 portfolio, or even in this case from $500,000 portfolio or $200,000. It doesn’t matter. You’re withdrawing $30,000 to go buy a car. And you were making an average rate of return of 5% or 6% on that. So let’s say 6% because that goes into 72, 12 times. Right? Alright, so here we go. We’ve got our formula 12 times. What would the $30,000 have doubled to in 12 years? 30,000 times 2 is what? Bailey: 60,000. Bob: Okay. What would it have doubled to in another 12 years? 60,000 times 2 is? Bailey: 120,000. Bob: Correct. So let’s look at you’ve withdrawn $30,000 from a portfolio to go buy a $30,000 car. Had you kept that $30,000 in the portfolio, it would have grown to $120,000. Now, I’m going to ask a trick question of you. Hopefully, you’ll get it right because we’re recording. What’s that $30,000 car going to be worth in 24 years? Bailey: Not $120,000. Bob: Exactly. Now remember, cars depreciate. It might be worth $5,000 or $6,000. So what has that car cost you? You withdrew $30,000 from your portfolio to go buy that new car. What was the true cost of that car over say a 24 year period. Bailey: I mean, at least $115,000. Bob: That’s right. You got it. So the Rule of 72 works not only on saving and doubling money, but you’ve got to think about the Rule of 72 anytime you want to withdraw money in a large lump sum amount from a portfolio and what that’s costing you over the years, and is that a wise choice because of how it’s compounding on itself? Bailey: Wow. I had never even thought about that because again, I’m 26, I’ve plenty of time to save, but also I can make this big expenditure right now because it won’t affect me 10 years from now. Bob: Yeah. So even if you don’t have the $30,000, but you’d go borrow the $30,000 to go buy that vehicle. Now, you’re having to pay money for that vehicle. Now I’m not saying you don’t need a car. Everybody needs a vehicle, but you’re paying money towards that vehicle when you could have been doing what? Bailey: Saving. Bob: You could have been saving. You got it. So that’s why when I heard about the Rule of 72 so many years ago, a light went on inside of my head. Hopefully, that’s going to happen with somebody listening today that every single month or year they procrastinate and wait to start saving, it’s costing them this much. Also, rate of returns. When when you figure in rate of returns, like I mentioned in the beginning, you’re lucky today if you can go to the bank and get 1% on your money in a CD. Maybe 2%. At 1-2%, how many times does 1 go into 72? That’s a simple one. Bailey: 72. Bob: How many times does 2 go into 72? 36. I can do all this stuff in my head. I don’t even need a calculator. Okay. So when you have money in the bank, now I understand it’s good to have some there for emergency reserves, but not too much. You want to get that money invested, because at a 1% rate of return, it’s going to take 72 years for that money to double versus if you’re making a 6% rate of return, it’s going to take it 12 years to double. Now, there is risk and reward, and you’re taking more risk. And we were talking about a scriptural principle behind that earlier, and it’s called the parable of the talents. It’s over in Matthew 25:14-30. And it talks about a master and he gives one talent to one servant, three talents to another servant, and five talents to another servant. Okay. Now remember one gets five, one gets three, one gets one. Who has the most to lose of these three servants? Bailey: The one with five talents. Bob: Yeah. The one with five. But what is the one with five talents do? Bailey: He invests. Bob: He invests it. And when his master comes back, he says to him, master you’ve given me five talents. Here is another five. And the master says, well done good and faithful servant. You did something with what I gave you. The one with two had more to lose than the one with one, he does the same thing. But what does the one that was given the one talent do with it? He had the least amount to lose, and then what does he do with it? Nothing. He does nothing with it. And the master is so upset with him. He says, give it to the guy with five who did something with it, which goes back to the story of what are we doing with what God has given us. I understand risk and reward. The lower the return, the least amount of risk, the higher the risk, hopefully more return. Now that’s not always the case because higher risk is higher risk, right? But in this biblical example that’s been given to us, you take this scripture. You don’t want to take scripture out of context. So you also want to look at other scriptures and how that plays into this scripture and investing. And you come over to Ecclesiastes 2 and Solomon’s talking about – one of the wealthiest men that ever lived in the world – he said, give your portions to seven, even to eight because you do not know what disaster may come upon the land. So Solomon, the wealthiest man in the world did not go put it all in the ground and bury it. He did not go put it all in some high risk venture, he diversified amongst six to seven different ventures. So, diversification is extremely important when we talk about rates of return and the Rule of 72s and compounding and how all this works together. It’s mind boggling. It’s hard to know what to do. This is why I come back to scripture that says plans fell from lack of counsel, but with many advisors, they succeed. That’s in Proverbs 15. And then you come over to Ecclesiastes and it says, pity the man that has no one to watch his back. Two or three are better than one. So as believers, it’s good for us to come together and help one another with this money game and investing and using biblical principles and the Rule of 72 and understanding how that applies. I know not everybody’s going to be a nerd like Bob Barber and love these mathematical formulas. You’ve got other things you’d rather do and you love to do, but understanding the Rule of 72s and how it applies to investing and compounding and saving money, as well as withdrawing money, is very important to understand. We’re going to put this all on the podcast website so that you can go to it. You can see the definition of the Rule of 72s. You can understand compounding. Then just get yourself out a piece of paper and a calculator. All of us have that on our phone, and start figuring how the Rule of 72s can apply to investing. Every time you want to withdraw money from a portfolio that’s clicking along and doing a good 5% or 6% return, think about what are you withdrawing that money for and where’s it going? And wherever it’s going, is that going to be compounding upward or is it going to be losing value? And that’s what I’ve done in my own life over the years. And what this old guy now wants to teach others about how money works and this applies right into that formula. Bailey: Amen. Amen. Well, I think that’s one of the reasons that I love this podcast is I know that not everybody looks at the world through the lens of math and the lens of money, and money can feel, or saving or investing can feel, really overwhelming. I know it does to me. It feels like this big formula that I cannot figure out, but this just simplifies it. This just simplifies it so much so that it feels tangible to a 26 year old or to somebody who hasn’t started yet, but could start today instead of waiting another month to start. Bob: And it applies not only to a 26 year old, it applies to a 56 year old and even a 76 year old because it all has to do with how often money’s going to double and don’t think it doesn’t apply to everyone. It applies to everyone. It does really apply. The younger, you are, the more important it is to understand the Rule of 72. And we have definitely gone over how this thing works. So we’re not going to spend another hour on this. I hope that this helps everyone in the future. Hey, give me a call if you don’t really understand what I’m talking about, and we can go through some mathematical formulas and I’ll show you how this works. I’ve done it right in my office. I get a big white pad, that kind that you stand up in front of. I take the dry erase marker or whatever, and I can draw on it and I can show you how this is so powerful. Bailey: Yeah. So if you want to give us a call at the office, the number is 830-609-6986, and Bob can walk you through all those things. Bob: Sounds great. Bailey: Alright. Thanks Bob. [CONCLUSION] That’s all for now. We invite you to listen to all of our past episodes covering many financial topics from a Christian Perspective. To make sure you don’t miss any of Bob’s upcoming episodes you can subscribe to Christian Financial Perspectives on iTunes, Google Play Music, Spotify, or Stitcher. To learn more about integrating your faith with your finances, visit ciswealth.com or call 830-609-6986. [DISCLOSURES] Investment advisory services offered through Christian Investment Advisors Inc. DBA Christian Financial Advisors®, a registered investment advisor. Comments from today’s show are for informational purposes only and not to be considered investment advice or recommendations to buy or sell any company that may have been mentioned or discussed. The opinions expressed are solely those of the host, Bob Barber. Bob does not provide tax advice and encourages you to seek guidance from a tax professional.