Rate of Return

The Magic of Compound Interest

One of the most important discoveries in finance is the Rule of 72. It show you how to calculate the effect of compound interest with a very simple formulaTake 72 and divide it by rate of return. The answer is the number of years it takes to double your money.

72 / Rate of Return = ears to double your money

for example with 4% interest it takes 18 years to double your money.

The difference between $10,000 at 4% versus 12% is $600,000 

20 years salary of someone who earns $30,000 annually.

The Rule of 72 unveils the poerful impact of compound interest on money. It also reveals 2 types of people:

People who don't understand how money works - theu end up working for monet.

People who understand how monwy works - they let money work for them.

Wealthy people tend to spend time learning and understanding ow money works. They look for advice and solutions to get better returns for their money.

A lot of poor people lack knowledge about personal finance. Som don't care to understand. Many have no plan and little savings. What savings they have are usually put into accounts with a low rate of return. Their money doesn't work for them.

Compound interest works both ways. It can make you, and it can breake you. If you owo money, the compound interest on your debt can ruin you. As a result, many people keep paying the bill with high interest. Despite numerous payments , the balance of the bill barely goes down because high interest on he balance continues to compound. Sometimes , it feels as if it 's impossible to pay the balance off.

Simple interest vs. Compound interest

Let's take an example of Mr. A puuting $10,000 in a savings vehicle with %8 simple interest and Mr. B putting $10,000 n another savings vehicle with 8% compound interest annually.

Mr. A - Simple interest

                                                          Total

Year 1 : $10,000 * 8% = $800            $10,800

Year 2 : $10,000 * 8% = $800            $11,600

Year 3 : $10,000 * 8% = $800            $12,400

Year 10   ---------------------->           $18,000

Mr. B - Compound interest

                                                          Total

Year 1 : $10,000 * 8% = $800            $10,800

Year 2 : $10,800 * 8% = $864            $11,664

Year 3 : $11,664 * 8% = $933            $12,597

Year 10   ---------------------->           $21,589

With simple interest, Mr. A earns $800 very year or $18,000 over 10 years.

With compound interest, the savings vehicle of Mr. B gives him 8% on combined principal plus interest for the next year's calculation. When you see the difference between simple and compound interest, you now understand how powerful it can be.

The Real Rate of Return

When you save or invest, it's important to have a good rate of return. But what's the real rate of return? In other words, what do you really get?

Example 1:

If you save                             $100

at 3% interest                        + 3

Pay tax at 25%                      - 0.75

                                           -----------

Net after tax                          $102.25

Inflation at 3.5%                    - 3.5

Actual return                          $98.75

                    You Lose!!!!!

Example 2:

If you save                             $100

at 5% interest                        + 5

Pay tax at 25%                      - 1.25

                                           -----------

Net after tax                          $10.75

Inflation at 3.5%                    - 3.5

Actual return                          $100.25

             You Must get about 5% or more in interest to beat taxes and inflation.

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