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Rule of 72: Understanding the Secret of the Wealthy


The rich gets richer and the poor poorer. Most of the time, the missing link is "information." The wealthy people know something that average people don't and that is financial education. One of the secrets of the wealthy is that they know how to let money work for them. 

However, most of us don't know how to let money work, thus we work hard for the money. But the challenging part is that nobody wakes up at 6 or 7 am and says, "yehey! It's time to go to work!" Unless we know how to let money work, we are doomed to work for the rest of our lives. So how does money work?

Money works through the help of interest rates. There are two types of interest rates: Simple and Compounding Interest.

Simple Interest:
Example: 1% interest on the principal per year.
100 (principal savings)
After 1 year: 101
After 2 years: 102
After 100 years: 100 becomes 200! Exciting!

Compound Interest:
Understanding the magic of compound interest:
Example: 1% interest compounded annually
100 (principal savings)
After 1 year: 101
After 2 years: 102.01 (because your 1 peso also earns 1% interest)
After 3 years: 103.03 (the magic of compounding!)

Experts have derived a simple formula to estimate the number of years your money doubles through compounding called the "Rule of 72." The rule states that 72 (constant) is divided by the interest rate per year equates to the number of years your money will double. 
72 / i = # years money doubles

Using the values above, 72 / 1% = 72 years.
Therefore: 100 becomes 200 after 72 years (compared with 100 years in simple interest rates)

Another interesting thing to note about the magic of compounding: small changes in the interest rate = millions in the end result of your savings.

Example: 100,000 invested in 4%, 8% and 12% at age 29. Using the rule of 72, the number of years your money will double is 18, 9 and 6 years, respectively. At retirement age of 65, see the big difference below.

The secret of the wealthy is learning how money works
The secret of the wealthy is learning how money works
Obviously, the bigger the interest, the bigger the result. But the not so obvious beauty of compounding is, the difference between 4 and 8% is 2 times but the difference of 400K and 1.6M is four times! The difference of 4 and 12% is thrice but the difference of 400K and 6.4M is 16 times!!! Now that is very powerful!

Try going inside the banks, you get a priority number, line up at get less than 1% per year in your regular savings account. While mr.wealthy client goes directly to the bank manager, and negotiates how much interest rate their bank will give his 10M.

Now look closely: most Filipinos lack financial knowledge, they go to their favorite bank or cooperative, deposit their 100K at age 29, assuming they get 4% interest (in reality it's even way lower) per year. By the time they go out, the banks will invest it or lend it at 12% interest per year. When they retire at age 65, their 100K becomes 6.4M, they get 400K and the banks keep the 6M.

However, I'm not saying you withdraw all your funds now in your bank accounts. There is nothing wrong with that, it's just that due to lack of financial literacy among Filipinos, we are not able to maximize our hard-earned money. We need to understand and learn about alternative financial vehicles and investment programs that offer better rates of return. Now, who says financial education is expensive or useless? Try financial ignorance, it will cost you 6M.

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