A Little Math Goes a Long Way in Preparing for Your Future

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We all want financial freedom, a life of abundance. We hope to have more than enough to cover our needs, to provide for meaningful experiences, to prepare for comfortable retirement years, and to help family, friends and charities along the way. In that pursuit, one of the ways we talk about accumulating wealth is “doubling” our money. But do we really know what that means, and what it takes to get where we want to be?

RuleOf72Let’s talk about the rule of 72. You know, people often think they understand this rule, but let’s see if you do. The rule of 72 says that you take whatever interest rate you might be earning on your money, divide that into the number 72, and that will tell you how many years it takes to double your money.

So, let’s say you were earning 8% interest – 72 divided by 8 is 9. Your money will double every nine years. That’s based upon a one-time lump sum investment. If you were earning 9%, you’d double your money every 8 years. If you were earning 7.2% (72 divided by 7.2), that would mean you’d double your money every 10 years. At 10% your money would double every 7.2 years. You get it, right?

Well in a way, the reciprocal of that equation is also true.

If you look at how many years it takes to double your money and divide that into 72, that can help give you the compounded interest equivalent, or the appreciation rate, that it took to get there. So when somebody says, “Hey, I bought a piece of real estate for $100,000, sold it, and doubled my money,” that doesn’t necessarily mean anything to me until I know … what? Until I know how long he had to hang on to the property to double his money, or whether he leveraged his money, or if he used all of his own money (vs. Other People’s Money) to purchase the property.

If he used all of his own money and paid $100,000, and he held on to that property for 10 years before selling it for double, I’m not that impressed. Why? Because 72 divided by 10 years means that he got the equivalent of 7.2% appreciation, which is a little bit less than the national average on metropolitan American real estate over the last 40 to 50 years.

Now let’s take a look at the effect of inflation when it comes to accumulating wealth. What a lot of people don’t understand is you need to know how much today’s dollar will be able to buy down the road, when you need those dollars the most.

Let’s say you’re age 65, and if you tighten your belt, you can get by on $3,000 a month for gas, groceries, prescriptions and golf green fees. Now let’s say inflation is averaging 5% a year. How much would you need in 30 years, when you’ve gone from age 65 to 95? (Believe it or not, that’s about the life expectancy for a Baby Boomer couple.)

If you can get by on $3,000 a month now, how much will you need to buy the same gallons of gas, groceries, prescriptions and golf green fees in 30 years? Doing the math, you’d divide 5% inflation into 72, which means the cost of living will double every 14.4 years. For the sake of simplicity, let’s round that to 15 years. Now let’s consider how many 15-year periods there are in the next 30 years. That’s easy: two.

So that means if you can live on $3,000 a month now, you’ll need $6,000 a month 15 years from now. Before you say good-bye to loved ones at age 95, your financial needs will double one more time, and you’ll need $12,000 a month to guy the same gallons of gas and loaves of bread that you could have bought for $3,000 a month 30 years earlier.

Now what if inflation went to 7.2%? You would need that $12,000 a month in 20 years to buy what $3,000 a month bought 20 years earlier. If inflation were to go to 10%, that would mean in less than 15 years you would need $12,000 a month to buy what $3,000 a month bought just 15 years earlier.

When I present this to people, this is the point at which the light bulbs are going off and the worry lines are setting in. Preparing for the future isn’t as simple as many think. Without taking a good look at the realities of inflation and using the Rule of 72, many people are caught off guard. Now it’s one thing to be surprised during a little math exercise. It’s another to be stunned by reality when you’re mid-retirement, at age 80, struggling to make ends meet.

Don’t let reality sneak up on you. Invest in vehicles that will provide liquidity, safety and a rate of return that will help you. Prepare so that inflation can help you instead of hinder you. Do all that you can so that you can enjoy a life of abundance now, and into your later years. Because you—and your loved ones—deserve it.

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