The Rule of 72 - Grow Your Business with Raj Jha

First Principles Thinking for Entrepreneurs

The Rule of 72

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Understanding the Rule of 72

Short Answer Quiz

Instructions: Answer the following questions in 2-3 sentences each.

What is the Rule of 72 and what does it help you calculate?
How is Albert Einstein connected to the Rule of 72?
Using the Rule of 72, calculate how long it will take for an investment to double at an interest rate of 9%.
Explain the difference between investing in a 401k and investing “wholesale.”
According to one of the sources, what is the average savings account interest rate in the US? Why is this problematic?
How can understanding the Rule of 72 help you make better financial decisions?
According to one of the sources, what is the average credit card interest rate? How does this relate to the Rule of 72?
Explain how the Rule of 72 can be used to calculate the growth rate needed to double an investment within a specific time frame.
Why is it important to consider the time frame of your investments when using the Rule of 72?
One source uses the example of a newborn child and saving for college. Explain how the Rule of 72 can be applied in this scenario.

Short Answer Quiz Answer Key

The Rule of 72 is a simple calculation that estimates how long it takes for an investment to double, given a fixed annual rate of return. You divide 72 by the interest rate to get the approximate number of years for doubling.
Albert Einstein did not discover the Rule of 72, but he popularized it by highlighting the power of compound interest.
Using the Rule of 72, 72 divided by 9% equals 8 years. It would take approximately 8 years for the investment to double at a 9% interest rate.
Investing in a 401k is considered “retail” investing, where you have limited control and often lower returns. Investing “wholesale” refers to investing directly in assets through platforms like Fidelity or Vanguard, potentially yielding higher returns.
According to one source, the average savings account interest rate in the US is 0.06%. This is problematic because at such a low rate, it would take an incredibly long time for savings to double, losing value to inflation.
Understanding the Rule of 72 can help you make better financial decisions by allowing you to quickly assess the potential growth of investments and compare different investment options with varying interest rates.
According to one source, the average credit card interest rate is 20.47%. Applying the Rule of 72, this means that credit card debt could double in approximately 3.5 years if not paid off, highlighting the importance of managing debt responsibly.
To calculate the growth rate needed to double an investment within a specific time frame, you divide 72 by the desired number of years. This will give you the required annual growth rate.
Considering the time frame of your investments is crucial when using the Rule of 72 because it helps you understand the impact of compounding over time and choose investments that align with your financial goals.
In the example of saving for a newborn’s college, the Rule of 72 can be used to determine the necessary rate of return to reach a desired savings goal within 18 years. By calculating the required interest rate, parents can choose appropriate investment strategies to fund their child’s education.

Essay Questions

Discuss the limitations of the Rule of 72. When might it not be an accurate predictor of investment growth?
Compare and contrast the benefits and drawbacks of investing in a 401k versus investing “wholesale.”
Explain the concept of “purchasing power” and how inflation affects the value of money over time. Why is it important to consider inflation when making investment decisions?
Analyze how the Rule of 72 can be used to understand the negative effects of credit card debt. How can this knowledge empower consumers to make responsible financial choices?
Using real-world examples, illustrate how the Rule of 72 can be applied to different financial goals, such as retirement planning, saving for a down payment on a house, or funding a child’s education.

Glossary of Key Terms

Compound Interest: Interest calculated on the initial principal and also on the accumulated interest from previous periods. Essentially, interest earned on interest, leading to exponential growth over time.

Rule of 72: A simple calculation used to estimate the number of years required to double an investment at a given annual rate of return. Calculated by dividing 72 by the interest rate.

401k: A retirement savings plan sponsored by an employer, allowing employees to contribute a portion of their pre-tax income to investments that grow tax-deferred.

Investing “Wholesale”: Refers to investing directly in assets through investment platforms like Fidelity or Vanguard, potentially offering lower fees and greater control over investment choices compared to traditional retail investment accounts.

Purchasing Power: The amount of goods and services that a unit of currency can buy. Inflation erodes purchasing power over time as prices rise, meaning the same amount of money buys less in the future.