20-year financial veteran Paul Murphy shows you why the Rule of 72 is the most powerful (and dangerous) personal finance rule to master.
It’s the most powerful rule in all of personal finance.
A simple formula that has helped geniuses like Warren Buffett turn millions into billions.
And a powerful weapon that Canadians can either use to build wealth—or have it used against them by predatory creditors, banks, and high-interest loan products.
If you read personal finance books, you’ve heard of the Rule of 72 or the Power of 72 rule.
In this article, I’ll explain how this rule can either make you rich or keep you in debt.
As you’ll see, there’s a darker side to the Rule of 72, a mechanism that banks and lenders exploit to keep uneducated Canadians deep in debt.
The Rule of 72: how the rich get richer
Financial advisors use the Rule of 72 to calculate the impact of compound interest.
With this rule, you can quickly calculate how long it takes your money to double. This reveals the positive effect that compound interest can have on your future ability to buy a house, take a vacation, or retire in comfort.
To do this, divide the number 72 by the percentage rate earned on an investment.
Let’s say you invest $1,000 in a GIC. Your rate of return is 4% interest. 72 divided by 4 equals 18. In 18 years, your investment will double to $2,000. It will also continue to double every 18 years.
Or imagine that you receive a $15,000 inheritance from an aunt. It’s a lump sum of money—one that you might be tempted to spend now on a European vacation or new boat.
You decide to skip the vacation and boat, investing your money wisely. You find a financial planner and they get you a 6% yearly return.
72 divided by 6 equals 12. That means in 12 years, your money will double to $30,000. And in another 12 years, it will double again to $60,000.
In 24 years, your investment will grow from $15,000 to $60,000.
The dark side of the Rule of 72
At 4 Pillars, we help Canadians deal with overwhelming amounts of personal debt. I’ve seen the dark side of this rule—when the power of compound interest is turned against your financial future instead of working for you.
Banks, credit card companies, and high finance lenders will never teach you the negative Rule of 72. They don’t want you to know the reverse effect it has on your financial future.
For most Canadians, the interest rates for loans is much higher than investments making the Rule of 72 incredibly damaging.
The Rule of 72 should be taught in every school and every math class. Everyone should understand compound interest and how it can accelerate your financial security or your downfall.
Albert Einstein said, the Rule of 72 “is the greatest mathematical discovery of all time. He who understands it, earns it. He who doesn’t, pays it.”
How much will $15,000 of debt really cost you?
Let’s look at the same $15,000 but this time it is credit card debt you are carrying and the average interest rates of 18%. 72 divided by 18 equals 4.
This means with no payments your debt will double in only 4 years to $30,000 and double again in 8 years to $60,000 and so on.
Let’s compare the above two scenarios over a longer period of time.
You can see why the banks make such huge profits.
You can see why the banks want clients in debt.
And you can see why the teller at your bank would rather sell you a loan than a mutual fund.
The next time you are offered a loan, do the Rule of 72 calculation. It will protect you and help you understand the terms you’re signing.
But what if you’re broke and need to borrow money?
Of course, it’s easy for me to say not to get a loan. But sometimes, a loan is the only thing standing between us and losing our house. Some financial choices we make are driven by circumstances.
If you’re struggling in debt, speak to a local expert in one of our offices across Canada. We can educate you on your options and help you get off the debt treadmill that the Rule of 72 creates for millions of Canadians.