Doubling money
I have already talked about the power of compounding interest. The subject matter is quite a bulky one if one should delve into the math behind. But making money is not about the theories. If it does, a lot of college graduates (including myself) should have started financial management earlier. The fact is, financial literacy may have been taught in school. In my case, it was cloaked in such subjects as Engineering Economics (I excelled in this one). But the impracticality of theories made it only accessible to the financially keen to which I did not belong.
The power of compounding can be simplified to a famous approximation that quite resembles the exact equation. This is the Rule of 72. It was said to originate from a Mathematician friar Luca de Pacioli. But the idea might have predate his.
The Rule of 72 goes something like this: For some money put in an investment vehicle with r annual interest rate, the money will double in 72 ÷ r years.
Let's take a few examples.
Suppose you have a Php100,000 and decided to put it in a savings deposit at 1% annual rate (most banks today offer less than 1% for purely savings deposit). Applying the rule of 72, your money will become 200,000 in 72/1 = 72 years. Now, that's almost a whole lifetime!
Now let's see how the bank use your money. Suppose the 100,000 you owed to the bank is used in a housing loan at 10% annual interest (10% is already a conservative estimate in today's bank rates). The bank's (which is initially yours) money will double every 72/10 = 7.2 years.
To illustrate further, take a closer look at the following table and decide for yourself if putting your money in the bank is really a good investment decision.
That's only your money. Remember that banks have many clients having money similar with yours and some even have bigger capital. If you stroll along Ayala Ave. and Paseo de Roxas in Makati, those huge buildings you see probably belong to the banks and other financial institution. Banks make money because they're aware of the rule of 72 and the power of compounding interest in general. After banks pay you out the Php200,000 you accumulated in 72 years, they already accumulated huge wealth at your expense. That's a fact.
The rule of 72 is simple yet it helps you see the future growth of your money without much complication. It helps you question the credibility of the "double-your-money" schemes from financial institutions. And most importantly, it guides you any financial decisions you may need.
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For those who wanted to learn the exact equation anyway, here it is
The power of compounding can be simplified to a famous approximation that quite resembles the exact equation. This is the Rule of 72. It was said to originate from a Mathematician friar Luca de Pacioli. But the idea might have predate his.
The Rule of 72 goes something like this: For some money put in an investment vehicle with r annual interest rate, the money will double in 72 ÷ r years.
No. of years to double money = 72 / (annual interest rate)
Let's take a few examples.
Suppose you have a Php100,000 and decided to put it in a savings deposit at 1% annual rate (most banks today offer less than 1% for purely savings deposit). Applying the rule of 72, your money will become 200,000 in 72/1 = 72 years. Now, that's almost a whole lifetime!
Now let's see how the bank use your money. Suppose the 100,000 you owed to the bank is used in a housing loan at 10% annual interest (10% is already a conservative estimate in today's bank rates). The bank's (which is initially yours) money will double every 72/10 = 7.2 years.
To illustrate further, take a closer look at the following table and decide for yourself if putting your money in the bank is really a good investment decision.
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| How banks make profits out of your money |
That's only your money. Remember that banks have many clients having money similar with yours and some even have bigger capital. If you stroll along Ayala Ave. and Paseo de Roxas in Makati, those huge buildings you see probably belong to the banks and other financial institution. Banks make money because they're aware of the rule of 72 and the power of compounding interest in general. After banks pay you out the Php200,000 you accumulated in 72 years, they already accumulated huge wealth at your expense. That's a fact.
The rule of 72 is simple yet it helps you see the future growth of your money without much complication. It helps you question the credibility of the "double-your-money" schemes from financial institutions. And most importantly, it guides you any financial decisions you may need.
------------------
For those who wanted to learn the exact equation anyway, here it is
Read: Log of 2 to the base 1 plus r. In Microsoft excel, it can be written asno. of years to double money = log (1+r) 2
= LOG(2, 1+r)Just don't forget to substitute r with the appropriate interest rate.
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