Compound Interest & Rule of 72

Compound interest means that you earn interest on the amount you've saved, and then you continue to earn interest on the interest. This can go on and on as long as the money is left alone to accumulate interest moving you toward your savings/investing goals.

To achieve some kind of financial security, you would like your money to grow ever larger so you always have the power of compound interest working for you. To predict how long it may take before compound interest will double your investment use the 'Rule of 72'. Divide 72 by the interest rate you are earning and the resulting number will be the number of years it could take to double.

The best news, even investing small amounts can earn interest taking advantage of compound interest. As these small amounts grow they can become larger amounts.

As I just said to my friend recently while having some beers, everyone, no matter what their age, should split their investments this way by age group (beyond funding an emergency fund, having cash on hand):

Twenties – 10% bonds, rest in stocks (no-load mutual funds and max out your Roth IRA)
Thirties – 25% bonds, rest in stocks
Forties – 40% bonds, rest in stocks
Fifties – 55% bonds, rest in stocks
Sixties – 70% bonds, rest in stocks
(Roth begins to faze out so put the money in a no-load mutual fund)
Seventies – 85% bonds, rest in stocks
(if you invested wisely and do end up with more money than you are spending you should continue to invest/reinvest your money during retirement)

Some of you may be wondering, why should I do it this way? Well, bonds balance out any investment. As stocks go down, bonds go up and visa-versa. Also, people should not pull all of their money out of the stock market because stocks have always historically paid more than other investments.

Now this recommendation is in addition to having an emergency fund split between a money market or a high yield savings account and some tiered CD's that mature every year: this year, next year and maybe one in the third year, so you have three CD's each earning more than one CD locked away for a single year. As each CD matures you reinvest it for three years. Also, adding an additional amount to each reinvestment will allow your money to grow much faster.

Again I do have to say, I am no financial advisor nor am I saying this is how you should do it because I have no idea what the future holds or your financial goals. You should seek out other people’s advice like Suze Orman, Dave Ramsey, Jean Chatzky, and David Bach (among others) to learn more. (Clicking on their names will take you to my Amazon supported store.) Also, a good financial advisor can also help you make good investment decisions.

Happy Investing!

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