THE RULE OF 72

The year was 1987, I was in Grade 12, sitting in class, listening attentively to the teacher. Most of the students had a glazed look in their eyes, our teacher was talking about an investment rule change for RRSP’s. Here in Canada, RRSP’s is a personal retirement vehicle that individuals’ can use to reduce their tax liability to the Government.

Come on, don’t stop reading yet! I know about nine out of ten people reading this will stop right here, tuning out, as most of the other students in my class did that day. I am going to say to you, please don’t, MONEY is important, your retirement is important, and what you do from this day forward is important, the Rule of 72 is important, especially if you are younger.

I hope I convinced you to stay with me!

I came home from school that day, extremely excited, I could not wait to tell my parents what I had learned about RRSP’s. I do not know if they remember the day, but the day had a profound affect on me. That day started my lifelong love affair with learning about personal finance and investing. I can sit for hours reading books on the subject or discussing the topic, much to many of my friend’s dismay. It also, steered me towards college to do a Business Management: Accounting course.

After graduating I started my first job in the Account’s Payable Department of a small Oil and Gas Company. It was only two months later that I opened my first RRSP investment account. It was not a large amount that I put in, but I had to start somewhere, $25 dollars from each pay cheque was going to the investment account.

Step one of my plan was complete. Start investing. It was then that I really started reading and learning about personal finance and investing. One of the most intriguing things I learned from my research, was called the Rule of 72.

The Rule of 72 states, if you take the interest rate you are getting on your investment and divide it into 72, it will give you the number of years it would take to double your money.

My mind was blown!

You see back in the early 1990’s interest rates, unlike today, were exceedingly high. Some guaranteed investment certificates and bonds were paying ten percent. So that would mean that it would take an individual just a little over seven years to double their money (72/10=7.2 Years).

So, being the math person that I was, I went to work doing some math. I initially started with my monthly investment of $50 a month. I wanted to know how much I would have at retirement. I set my retirement age at three different intervals, which were 50, 55, and 60. I built three different spreadsheets to determine what age would work best for my retirement. At $50 a month, my calculations showed that the retirement amount I was hoping for would be much lower than what I wanted, even retiring at age 60. Therefore, I had to make some adjustments. After playing with the numbers, I ramped the monthly amount up to $200, with an interest rate of 10 percent, I found that by the time I retired at age sixty, my investments would be worth over $1,000,000. Wow! Then, if you increase that monthly amount, even by a small bit, the numbers were even more impressive. Imagine if you doubled your monthly amount to $400 a month. You could retire even sooner!

I really liked the rule of 72!

As I kept working, learning, and becoming more experienced as an accountant, I was able to earn more money and get to my monthly investment goal of $200 a month.

Now, before you all get excited for me, no, I am not yet sixty, and no, I did not reach my $1,000,000 goal. I did not even come close. Interest rates dropped, and life happened. I became ill in 2006 with an incurable auto immune illness that derailed my career and my path to financial freedom.

I, however, am not looking for sympathy from anyone. I want my story about the obscure Rule of 72 to inspire each and everyone of you to start putting money away for a rainy day. The nest egg, I did mange to squirrel away, helps me keep some of my bills paid every month. This RRSP investment account, that I set up when I was 21, will not run out until I am well into my seventies. Due to my illness, I was only able to add to my investments for less than twenty years. Imagine what I could have done if I had been able to continue with my strategy until I was 55 or 60. According to the Rule of 72, my investments would have been able to triple in value by then. It is not a large amount that I take out every month but without the money from my RRSP, life today would be so much harder for me. One of the things I have learned is that I really do not need as much money in retirement as I thought.

I hope you are all still with me!

Before I bore you all to tears with my love of personal finance, I will give you one more example of how I used the Rule of 72, about twelve years ago, to help a friend of mine. I have been known to answer questions and point people in the right financial direction, putting them on the right track about money, retirement, and investing. I am especially insufferable when someone comes right out and asks me for help. In the case of my friend, they wanted some hands-on help from me, which I was happy to give. I should say more than excited to give.

Their situation was that they wanted to retire between the ages of 55 and 57. My friend well receive a pension at retirement, but they were worried that the pension amount would not be enough, especially if their house was not paid off. Their hope, was to bridge the income gap from their retirement age of fifty-five to age sixty-five, at which time their government CPP and OAS pensions kicked in.

I got to work. Using the rule of 72, and another lovely thing called compound interest, I came up with a plan for my dear friend. First step, I had my friend open a bank account with an online bank. One that does not charge fees. They wanted something simple and easy that they could look after themselves, which is why I did not send them to a normal bank. Second, we determined how much they could afford to put in. My friend opted to invest $50 a week, which is $2,600 a year. My friend’s desire was to have an additional $400 a month coming in when they retired, until the age of sixty-five. My friend did not want to take any chances with their money. So, half of the money is currently invested in GIC’s (Guaranteed Investment Certificate), which is very safe, but low interest, and the other half is in a low to medium risk mutual fund. The interest rate being earned is approximately 3% each year, across all off the investments in the account. This set up is doing better than she or I had anticipated. My friend, when they retire, will be able to take out $500 a month until she turns sixty-five. My friend is extremely happy!

I tell this story because most people think they need tons of money to retire comfortable. It is just not so. Everyone’s situation is different, which is why, people should start early and give themselves the gift of investment time, letting the Rule of 72 work for them. My friend started investing with less than twenty years to go to retirement. Three years of her $500 monthly income is going to come from the interest and growth in her RRSP account. While the Rule of 72 shows that she did not double her money because her time horizon for investing was not long enough, nor the interest rates high enough, it did allow us to come up with a great investment plan that worked for her. The plan is going to get her to where she wants to be financially at retirement. Do not forget, she also lowered her taxes to the government by putting money in this RRSP account, receiving a tax refund every year.

Don’t you just love math!

If you are still with me and reading this, here is what I want the Rule of 72 to do for you:

1. If you do not have an RRSP account, go out and open one today. Most banks will help you manage the account and recommend an investment that is a good fit for you, based on your financial profile and risk tolerance. Make sure you use a bank that offers this service free of charge. Those of you from other countries should have similar investment vehicles, for example, the US has the 401K.

2. Start as young as you can and put in what you can afford right now, but have it come directly out of your chequing account (PAY YOURSELF FIRST). Do not procrastinate on this! The Rule of 72 works best over a longer period of time.

3. Take any tax refund’s and add some or all of that to your nest egg/retirement account.

4. If you get a raise, take 25% to 50% of that raise and add it to your monthly investment amount.

5. Stay out of credit card debt! This kind of debt will be a noose around your neck if it is abused!

6. Then sit back and watch your money grow. Do not get frustrated. The biggest growth comes after about ten to fifteen years. Trust me it is worth the wait.

The time to start thinking about your future is now.

I hope the Rule of 72 inspires you just as much as it has inspired me!