There is a saying that compound interest floats all boats. Read on to learn more about a simple math trick to approximate how long it will take your money to double.
Michelle Morris, CFP®, EA
BRIO Financial Planning
Let’s suppose your grandmother put $100 into a bank account for you that magically paid 4% interest. Then she forgot about it, never adding or taking out a penny. How long do you think it would take for that $100 to double?
You might figure that 4% of $100 is $4 so it would take 25 years to accumulate another $100. Good guess, but not right.
At the end of the first year you would have $104. But then that full amount would continue to earn 4% interest, so at the end of the second year you would have $108.16, at the end of the 3rd year $112.49 and so on until the end of year 18 you have $202.58!
Interest earning interest is called “compounding” and it is an investor’s friend. To quickly come up with the answer of 18 years you can use the Rule of 72. 72 divided by the annual interest rate = approximate number of years it take your money to double. 72 divided by 4% = 18 years.
OK, I’m not aware of a magic bank account currently paying 4%. But, if you invested $100,000 in a balanced diversified portfolio of 60% stocks and 40% bonds at the beginning of 2004 and held through the end of 2015 you would have earned compound rate of return of 6.4%** Would your money have doubled? Yes, because in 12 years (inclusive) you need a rate of return of 6% (12 years x 6% = 72) in order to double your money. In fact in this example your $100,000 investment has grown to $210,523. Not bad considering the 2008 debacle was in the middle of this. The ups and downs of the market can give investors headaches, and you can’t predict returns in advance, but there really are more up years than down. Time and diversification are on your side.
I recently reviewed a bank statement from Bank of America that was paying .02% on a savings account. How long would it take that money to double? Hmmmmm, 3600 years. Not encouraging. Here’s a simple way to earn 50x the interest. Move it to an online bank such as Ally bank. They are FDIC insured and currently paying 1%, Only 72 years to double your money. Your grandkid might actually live to see that.
**Source Dimensional Fund Advisors Matrix Book 2016, page 67