Perhaps you have already heard of it, or perhaps you haven’t heard of it yet. The rule of 72 is the most powerful rule in all of personal finance. It is a simple formula that has helped the rich get richer. A tool that has helped Canadians build their wealth. At the same time, it is also a very powerful tool used by creditors, banks, and high-interest loan products to keep people in debt. Collecting interest on that debt, of course, is their business.
The rule of 72 is a simple formula to help you increase your wealth. However, what many finance specialists might not tell you, is that it is also a tool that can be used against you to keep you in debt. In this article, we will review what the rule of 72 is, how it works, and how it impacts your debt.
What is the rule of 72?
In short, the rule of 72 is a formula to help you estimate how long it will take for an investment you have made to double. By dividing 72 by the annual rate of return, you’ll get an estimate of how many years it will take for your investment to duplicate itself. This reveals the positive effect that compound interest can have on your future ability to buy a house, take a vacation, or retire in comfort.
The rule of 72 looks a little something like this:
Years to Double = 72/Investment rate
Let’s say you invest $1,000 in a GIC. Your rate of return is 4% interest. 72 divided by 4 equals 18. In 18 years, your investment will double to $2,000. It will also continue to double every 18 years.
Or, as another example, let’s say you receive an inheritance of $15,000. Instead of spending it, you decide to invest your money. Your financial advisor says they can get you a 6% annual return on your investment.
So, 72/6 = 12. Therefore, in 12 years, your $15,000 will double to $30,000.
Now for the darker side of the rule of 72
As Albert Einstein once said, the rule of 72 “is the greatest mathematical discovery of all time. He who understands it earns it. He who doesn’t pay it.”
While the rule of 72 sounds amazing to wealth seekers, we have seen firsthand how the rule of 72 can also be used to increase your debt. Where instead of working for you, your compound interest is actually working against you.
Instead of you investing $15,000, let’s turn the tables around and say you have $15,000 of credit card debt. The average interest rate for credit cards in Canada is roughly 18%.
72/18 = 4. This means that in only four years, your debt will double to $30,000 if you only make the minimum payments. In eight years, that debt will double again to $60,000.
This is one way that banks make huge profits.
This is why banks want to keep their clients in debt.
And this is why bank tellers would prefer to offer you a credit card or a loan rather than a mutual fund.
Why is the rule of 72 important?
Not only does the rule of 72 help you determine how to invest your money, but it also determines what will happen to your debt. Before you make any investments or take on additional debt, the rule of 72 can help you decide whether you’re making the best decision with your money. Understanding this rule could help you avoid putting yourself further into debt. It also helps to explain why even though you’ve never missed a payment and consistently make ends meet, you never get off the hamster wheel of debt.
At GetMeDebtFree, we have seen firsthand how the rule of 72 is used against the consumer to keep them in debt. If you are tired of the hamster wheel life of debt, we just might be able to help. With our years of industry knowledge and client experience, we have had the fortunate opportunity of seeing many families and individuals pass through to much brighter financial days.
If you are looking for the best advice on how to consolidate your debt, fill out our contact form, and we will be in touch. Rest assured you will not get any pressure nor judgement from us. Our job is to help, not hinder.
Everyone’s reason for being in debt is different. Don’t be the victim of a shark looking to soak you with a less-than-ideal solution. Contact us today as we have already navigated the shark-infested waters so that you don’t have to.