The Rule of 72

Years ago, when I was just 15 years old, a wise older man shared with me a lesson that was truly amazing to me. He called it The Rule of 72. He explained to me that if you took the number 72 and divided it by your expected rate of return, that would equal the approximate number of years it would take for your money to double in value. Now this in itself was not the amazing part. What I am about to explain to you is...

He told me that is was important to save at an early age. The reason he explained was that when you are young you have a lot of time for your money to compound. Now I couldn't help but think, easy for you to say but I have hardly any money. Well he explained that soon I would be in a position to be able to save money. He explained that when you are young you typically have fewer serious expenses and that you haven't developed what he called a lifestyle. Later in life as your tastes for more extravagant items would develop and life would get more complicated and my tastes would shift to more expensive things and it would become more difficult to save. He cautioned I would likely be faced with a future of bills and the struggles of trying to pay them. He stressed that it was important to save when I was young while my lifestyle was modest and my savings could compound over time. Then he explained it wasn't all about your rate of return, while that was important, it was actually time that was the key. TIME was the most important part of the equation he stressed.

How much time? Well he painted me a hypothetical picture of the future of how things might unfold (remember I am only 15 years old at this point). He encouraged me to save $100,000 by the time I was 30 years of age, a princely sum even today. How could I do that? Well he explained if I was anything like himself, I would likely get a good education and not have much in the way of savings until I graduated from post-secondary education. If I was anything like him I would get summer jobs to pay for that education and strive to graduate debt free. Then I'd likely secure an entry level position and slowly climb the corporate ladder. If I was fortunate I would meet a similar hard working person whom I could call my spouse and they too would be in a similar employment position. So he said it would be potentially at least possible to each save $10,000 a year from the ages of 25 to 30. In other words I could save $10,000 per year for 5 years and she would do the same and we would then have $100,000 in savings if we really put our minds to it. And then life would get in the way and it would be very difficult to save on a go forward basis. There would be cars to buy, houses to mortgage and trips to enjoy. Children might arrive and there would be tuition bills down the road to potentially pay.

So then he painted a hypothetical scenario of what that $100,000 would do if say we earned a 10% return compounded annually on those savings. He said to me, how long will you work until you retire? Being 15, I quickly blurted out a number without much thought and one that was less than the average retirement age for most, so I said 58. He said OK and then asked what rate of return would these savings earn? I again blurted out 10%, as it was a nice round number and keep in mind interest rates were high back then. So then he said let's do the math. What is 72 divided by 10? I said 7.2. He said OK, let's round to 7. Fine. Then he said what is 58 - 30 (the age at which I said I wished to retire hypothetically, less 30 years of age, the point at which we would basically stop saving as life would become so complicated and the bills would start piling up). So then he asked me how many times does 7 go into 28? I did a quick calculation and said 4. He said good, so that is the number of times your savings should double, 4 times. So he went further - $100,000 would double to $200,000, $200,000 would double to $400,000, $400,000 would double to $800,000 and then finally $800,000 would double to $1,600,000. So I asked sheepishly, so if I did like you said and just did the hard part up front and we managed to saved $100,000 by the time we were 30 years of age and made a return of 10% compounded annually on these savings and never saved another dime we would have $1,600,000 when we were 58? In theory, yes he said quietly.   

Now I have to be frank. I am not 58 yet, nor do I actually want to retire at that age. So I still live my financial life in theory I guess you could say. However what is clear to me is that wise older man was in fact right. It has been harder to save once I crested age 30. I did in fact develop what he described as a lifestyle. I now enjoy a higher standard of living than I have in the past and my expectations have increased accordingly. Life has become more complex and more expensive for that matter. As a result, saving after 30 has become more of a challenge. On a positive note, I have noticed that my savings have begun to compound over time. So that wise older man really did help me by sharing his wisdom and explaining The Rule of 72 to me. Time is in fact a huge component to a long-term savings strategy. The compounding impact is tremendous. I couldn't help but wonder why they didn't teach me this in school? Never-the-less, this kind wise older gentleman took the time to share his wisdom with me. And now I am sharing it with you and hopefully you will share it with your children. Who was that wise older man that shared all of this with me?

Thanks Dad!

The opinions expressed are those of Fred Winterburn and not those of Manulife Wealth Inc. Inc. You may contact Fred atfred.winterburn@manulifewealth.ca

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