Back in the olden times a little physicist by the name of Albert Einstein came up with a law that should be taught to every high school student, but is hardly ever mentioned. It’s known in the biz as the law of 72. Here’s how it works. If you take the percentage rate quoted by an investment vehicle and divide it by 72 it will tell you how many years it will take for your money to double. Everyone knows that 7% is better than 3%. But how much better? Lets take a look.
For example, your 22 and Aunt Emma in Idaho leaves you $20,000 to do with what you please. Your banker tells you they have a Certificate of Deposit guaranteeing 3% forever. Well, take 2% and divide it by 72, you get 24 years for your money to double. So at age 46 you have a whopping %40,000 and then at 70 when you can retire you have a nice $80,000. Great! Well here’s the bad news… your money only doubles twice and at 3% your not staying ahead of inflation and your going to get taxed on that $80,000 so essentially you’ve lost money. Also, most C.D’s are 1 maybe 2%. So don’t buy C.D’s.
Now say you take that 20k from Aunty Emma in Idaho and put it in a professionally managed A-share mutual fund with Transamerica. This allows some diversification in the market, they take your 20k and invest it daily in thousands of different accounts and hedge the odds. Over the last 20 years say they’ve averaged close to 7% net of fees. So take 72 and divide it by 7, now it only takes about 10 years to double. Say the averaged stay strong at 7%. So at about age 32 you have $40,000, age 42 you have $80,000, 52 you have $160,000, age 62, $320,000, age 72 you can retire comfortably off the 20k from Aunty Emma with $640,000. Your money has doubled five times, you’ve stayed ahead of inflation, you still have some tax to deal with but I’ll teach you some ways to get around those later on.
Anyways, the point is in order to stay ahead of inflation and taxes you need to make at least 4-5% in your money net of fees. Don’t waste your time with C.D’s and other low interest investments if you are young and are building an estate. The extreme low interest investments are simply for stashing money away in low risk accounts so the money doesn’t suffer a loss.
jpratt68 