About a week ago, Bank Guru had a conversation on Twitter with Michael Jagdeo and he came to learn of a rule that sadly both of us were not informed on.
The rule that we were both unaware of was the Rule of 72, and like Michael says, no one should be getting a credit card without understanding it. To be honest, when I was younger, and looking into credit cards, I do remember my brother explaining something similar to me (probably was the same rule) however at that time I thought I knew more than him and ignored anything he said. Definitely wasn’t one of my better choices, but I have grown since then.
What is Rule of 72?
To put it simply, the Rule of 72 is a method for estimating an investments doubling time. It can easily be explained in two parts.
72 ÷ interest = # of years for your $ to double.
This means that if you are investing at 4% interest rate, then your money will double in 18 years (72 ÷ 4% = 18).
The second part to the rule is that the money you owe grows in a similar manner. This means that if you have a low interest rate credit card, carrying a rate of 11.99%, then it will only take 6 years for your debt to double.
What does this do for me?
The Rule of 72 can help anyone understand how much they are looking to earn while investing your money.
Micheal was able to offer a few tips on the implications of the rules:
- Your bank has a quota to sell you GICs. The more money they get at a lower interest rate, the more money they can invest at a high margin of profit.
- The average Canadian has a rate of return on their savings of .68%. The problem is that most Canadians have credit card debt at 19.99% and higher when it comes to credit cards. Therefore, if the our savings grows slower than the money what we owe when will we ever be out of debt?
- The bank also has quotas for Lines of Credit sales. Again, if we can get our customers depositing money at .5%, and we can lend them back that money at 4-12%, we’re in the money.
I personally find the second tip to be the mist important of the three. If your own money is growing at such a slow pace, while the money you owe is not, then when would you really be out of debt? The answer is simple, decrease how much you are saving, and put the majority of your money down on your debt. It does not make sense to save money for your retirement for example, but have to worry about paying off your debt in your golden years.
Hopefully, the Rule of 72 can help you in your next investment, as you determine how much money you can potentially earn.