If you just ask anyone along the street if they wanted to be a millionaire, they will say yes.
And almost all of them will tell you their best shot at becoming a millionaire is to win the lottery.
To be honest, I think the probability of winning big in lottery is like you getting struck by lightning and bitten by the shark at the same time while swimming in the ocean. I think you know the odds are not with you. But most people still think this is the fasting route to the millionaire status.
It is because of this mentality in most people that casinos and lottery operators are making billions annually.
There’s a Better Way
Yes. There’s a better way to your millionaire status. You may already know it, but somehow you have failed to apply it into your life. So, what is this easier way?
The Law of Compounding and the Rule of 72.
Yes. The moment you understand how the Law of Compounding and the Rule of 72 work, you are well on your way to your millions or even billions. Just ask Warren Buffett or George Soros.
The Rule of 72 is very simple. It tells you how many years it will take an investment to double in value. This is done by simply dividing 72 by the annual rate of return. For example, you have an investment portfolio that gives you 8% per annum. Applying the Rule of 72, you will know that in 9 years’ time, the value in the same portfolio shall be doubled (72/8 = 9 years).
Looking at the formula, you will notice that the higher the rate of return, the shorter the number of years needed to see your investment double in value. For example, if the same portfolio returns you 9% per annum, then you will need only 8 years to see your portfolio doubles in value (72/9 = 8 years).
Is this the same with debt?
Unfortunately, yes. This is the reason why people who are in credit card debt, chances of them getting out of it is very slim. For example, if your credit card company charges you an annual interest of 28% which is the average of most credit card companies, then you will see your debt doubles every 2.5 years (72/28 =2.5 years). At this rate of increase, your active income can never catch up with your repayment. Personal bankruptcy awaits.
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Ok. I hope you now know how the Rule of 72 can work for you or against you.
So, what is the big deal about the Law of Compounding?
In my opinion, the Law of Compounding is a BIGGER deal than the Rule of 72. Albert Einstein calls it the 8th wonder of the world and I agree with him totally.
For example, you have a child born today. You wanted your child to be a millionaire at age 65 when your child retires. You decided to start an investment portfolio for your child that gives you an average annual return of say 10%. So, how much do you need to set aside per day to reach your dream for your child? Make a guess. $5? $10? $20?
The actual answer is 54 cents per day.
At 54 cents per day, compounded at 10% per year will reap your child more than 1 million dollars in 65 years.
Can you afford to put aside 54 cents per day for your child? Of course, you can. Are you doing it? Most likely not. You would rather spend money on other material stuff for your child now than on his/her financial future.
I was made known to the Law of Compounding and the Rule of 72 by my multi-millionaire mentor decades ago. Now that he had passed on a few years ago, I hope to dedicate this article to him.
He showed me that if I save 1 cent a day and double it every day, it will compound to $5,368,709.12 at day 30. I was shocked. Take out your calculator and do the math. Make no mistake about it.
He told me that for any investment portfolio to compound at 100% is unrealistic and this is the reason why we must start early in life in order to be wealthy in our later years without having to depend on the government or charity.
He showed me a Mr A and a Mr B. They were both aged 25 years old. They both have the same dream of having 1 million dollars at age 65. And they both decided to invest in the same portfolio that gives them 8% returns per year.
Mr A decided to start immediately with $4,000 per year till age 65. On the other hand, Mr B decided to start 10 years later at age 35 with the same amount of $4,000 per year till age 65.
At age 65, Mr A’s account will be worth $1,119,124, but Mr B’s account will be worth only $489,383. By starting 10 years later Mr B may save on the $40,000 from age 25 to age 35, but he lost more than $500,000 as a result. Mr B did not achieve his goal of 1 million at age 65.
I hope this illustration shows you the importance of starting early and applying the law of Compounding and the Rule of 72 to secure your financial independence in your later years.
Thank you for reading this article.
CEO & Founder, AlgoInsights