Rule of 72
The Rule of 72 is an interesting formula used in the financial world.
In order to determine either the impact of inflation rate and compounding interest returns, the rule of 72 is widely used. Here’s a daily example on how we can apply it.
A Ramly burger cost RM 1.50. Say the inflation rate is going steady at 5% yearly on the ingredients that makes up the Ramly burger, how much time would it take for the same Ramly burger to cost RM 3.00?
72/(Interest Rate)= Number of Years
72/5 = 14.4 years
Let’s say you just struck a lottery ticket and won RM 500,000. You decided not to let anyone know about it and kept it in your milo tin that doesn’t generate any interest. After 15 years, you realized your RM 500,000 can now only afford half the buying power it used to command. So, in order to determine the culprit which did this to your money, you calculate using the “Rule of 72”:
72/(Inflation Rate) = Number of Years
72/(Inflation Rate) = 15.0
Inflation Rate = 72/15
Infalation Rate = 4.8%
Hence, inflation is at work here, eroding your Ringgit at 4.8% throughout the entire 15 years.
How about applying the Rule of 72 in doubling your money?
You currently have RM 500,000. You would like to double your money in the next 10 years to RM 1 million. So, with Rule of 72, we can figure out what kind of investment vehicle is going to help you reach that Million Ringgit Goal.
72/(Interest Rate) = 10 Years
Interest Rate = 72/10
Interest Rate = 7.2%
There you go, you will need an investment vehicle that can give you up to 7.2% interest rate to double your money.
Normally, this would mean putting those money in a lower risk fixed income mutual fund or a dividend yielding mutual fund. There’s no way you can get such interest rate with the current fixed deposit rate.
Alrite, that’s all for “Rule of 72”.
It’s amazing how much you can derive from this simple formula.