We’ve all heard “Don’t work for money, make money work for you”. Though working for money or not can be subjective, making money work for you is never debatable. The power of compound interest, meaning earning interest on interest on the invested sum, is not new but often overlooked. Let’s see a simple trick to calculate the number of years your investment requires to double in amount.
If you invest Rs. 15,00,000 / $20,000 in real estate, what kind of return should you expect in 10 years? What is considered a good investment?
Let us say I bought a property for Rs. 15,00,000 (USD 20,000) about 10 years ago and sold it for Rs. 30,00,000 (USD 40,000)- did I make a good return on my investment? (Considering the dollar rupee exchange rate fluctuation, it may not be USD 40,000 (more like USD 30,000).
One thing I have realized in the recent past is that oftentimes you think you made a good investment, however if you do the math, calculate the return after your expenses and more, it does not add up.
I was preparing for a kids entrepreneurship class and wanted to brush up my basics on Compound Interest. Albert Einstein famously said that ‘Compound Interest is the 8th wonder of the world’.
Compound interest – This video from Khan Academy illustrates the basics of Compound Interest. Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest – Source : Wikipedia
The Rule of 72
Let us say you invested $10,000 in stocks and you are getting a compounded return of 10% every year. How long does it take for your money to double to $20,000? This video from Khan Academy offers a very simple trick. Divide 72 by the rate of interest. In this example, 72/10 = 7.2 years. So if $10,000 is compounding at 10% every year, you can expect the money to double in 7.2 years to $20,000. However let us say the money is compounding at 5% a year, (72/5) – It takes 14.4 years for your $10,000 to double to $20,000.
I have enjoyed learning about the rule of 72. You can use it as well when you invest for a return. You should expect your money to double every 7.2 years assuming you are compounding at 10% every year. Happy Compounding!