The year 1972, for those of us old enough to remember, was a year that will forever be etched in our brains as the most important year in hockey history. It was the year of the famous Summit Series between Canada and the former Soviet Union. The Summit Series was organized to determine true hockey supremacy. The dramatic eight-game series went down to the wire and was only determined when Paul Henderson scored with just 34 seconds remaining in the eighth game. What drama! This series paved the way for many more hockey exchanges prior to professionals being allowed to compete in the Olympics and in a small way, I believe, also helped thaw East/West relations during the Cold War. The year of ’72 was an important one for hockey fans.
And 72 is also the most important investment number that should always be etched in our brains when we think about investment returns. It’s integral to understand how it impacts investment returns, and why small differences compounded over long time periods make big differences in end results. I am perpetually surprised by how few people know the “Rule of 72,” as I have known it since I was a youngster, probably before the 1972 Summit Series. It is a very simple but critical investment rule: 72 divided by the annual rate of return equals the number of years to double your money. I don’t know why it works, but it does and is a great way to approximate the value of a current investment at some point in the future.
If you go to the bank and buy a $10,000 GIC (Guaranteed Investment Certificate) at 2% interest, it will take 36 years to double your money (72/2=36). 36 years from now that certificate will be worth $20,000.
If you buy stocks and achieve 12% annual returns, you will double your money every six years (72/12=6). In the same 36 year period you will experience six doubles: $10,000 x2x2x2x2x2x2 = $640,000. Which would you sooner have 36 years from now, $20,000 or $640,000? Many will argue that 12% annual returns aren’t realistic but I have achieved 11.7% over 25 years in my RRSP and have other accounts ranging from 9% to 17% with shorter timeframes.
Let’s look at another scenario: How much difference will there be between 6% and 8% annual returns, over 36 years? The seemingly small 2% difference, similar to equity mutual fund fees, compounds to represent twice the difference. The money doubles every nine years with 8% returns (72/8=9), for four doubles in 36 years. With 6% returns the money doubles every 12 years (72/6=12), for three doubles in 36 years. Therefore with 8% returns, $10,000 would become, $10,000 x2x2x2x2 = $160,000, but with 6% returns, just $80,000 in the 36 year period.
The “Rule of 72” can also be used to calculate other compounding factors. If inflation averages 3% per year what will a $10.00 item cost in 24 years? If your city is growing at a 4% annual pace what will its population be in 18 years?
The compounding effect of the “Rule of 72” is why I am such an advocate of:
- Stocks over lower return investments, while accepting the volatility of stocks.
- Investing over speculating, as 9-12% annual returns build significant wealth over time.
- The younger you start the better.
- Starting with small amounts is very productive, and
- Managing your own money (while not the answer for everyone) and saving fees can lead to big differences in outcomes.
During a 35+ year career in agriculture, Herman VanGenderen became an active investor in stocks and real estate. His book “Stocks for Fun and Profit ~ Adventure of an Amateur Investor” is available at www.amazon.ca/Stocks-Fun-Profit-Adventures-Investor/dp/1773028626
MORE ABOUT ACTIVE INVESTING:
- U.S. earnings beaters are gold for your portfolio
- An All-Star review
- The fallacy of a “stock-picker’s market”
- Don’t get greedy in the late stages of a rally
The post Why “72” is the most important number for investors appeared first on MoneySense.