Home' Trinidad and Tobago Guardian : July 20th 2014 Contents SBG16 PERSOANL FINANCE
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt JULY 20 • 2014
Albert Einstein reportedly
described compound interest
as "the most powerful force
in the universe." What is
compound interest? How
will it help you grow your
investments, retire early, or become a mil-
Compound interest refers to the interest
that is generated by your principal PLUS its
Don t worry if that sounded like gibberish.
Just stick with me for a second.
Imagine that you put $100 into a retirement
investment account. It earns interest at a rate
of 10 per cent per year. At the end of Year 1,
you have $110.
You start Year 2 with $110 in your investment
account: $100 from the principal, and $10
from the interest. You keep the full $110, BOTH
the principal and the interest, invested through-
out Year 2. By the end of Year 2, your invest-
ment has grown by another $11, for a total of
Notice that in Year 1, you earned $10 in
interest, because the only money that you had
was the principal. But in Year 2, you earned
$11 in interest, because you had the principal
PLUS the first year s interest. In other words,
that extra $1 represents interest that com-
pounded on top of your interest.
You start Year 3 with $121 in your investment
account. You earn 10 per cent, or $12.10. At
the end of the year, you have $133.10.
Notice how your 10 per cent payout has
grown: from $10 the first year, to $11 the second
year, to $12.10 the third year. This is because
interest is compounding on top of previous
The fourth year, your 10 per cent payment
will be $13.31 (which is 10 percent of $133.10),
which means you ll end the year with $146.41.
Notice that at this point, you ve earned $46
on your original investment of $100. Not bad!
What if you hadn t reinvested your returns?
In Year 1, you get a 10 per cent return. You
keep the principal, the original $100, invested,
but you spend the extra $10. At the start of
Year Two, you only have $100 invested.
You do this every year -- keeping the original
$100 invested, but removing the extra $10. By
the end of Year 4, you ve made only $40, not
$46.41, because you didn t let the interest
"Big deal," you might be thinking. "$6 bucks
is not a lot of money."
True. But imagine doing this with $10,000.
Using the same formula, you ll earn $4,600
on your original investment by the end of the
fourth year, and that $6 has now turned into
Better yet, imagine doing this with
$100,000. You d earn $46,000!
Of course, most investments don t give con-
sistent 10 per cent returns. Investing legend
Warren Buffet predicts that the stock market
will give 7.0 per cent returns through the next
decade or two.
Triple your money with this simple
rule of thumb
Some of the most important math skills
that everyone needs, it turns out, are the basic
ones they learned in primary school. Simple
double-digit multiplication and division can
help you TRIPLE my money.
There are two handy rules of thumb that
are used when calculating how well an invest-
ment will pay off. One is called the "Rule of
72." The other is the "Rule of 115."
The Rule of 72
The Rule of 72 states shows you how quickly
you ll double your money. Divide 72 by the
interest rate. This is the number of years
required for your money to double.
For example, if your money is earning an
8.0 per cent interest rate, you ll double your
money in nine years (72 divided by 8 equals
9.)If your money is earning a 5.0 per cent
interest rate, you ll double it in 14.4 years (72
divided by 5 equals 14.4.)
If your money is earning a measly 1.0 per
cent interest rate, it will take you---yep, you
guessed it---a whopping 72 years to double it.
Remember: this is a "rule of thumb," not
an iron-clad law. The Rule of 72 doesn t adjust
for details that make a significant dent in your
returns, like taxes and your fund s adminis-
But it s a useful guide for making a quick
mental calculation of how long it will take
you to turn $10,000 into $20,000. Besides,
it s a fantastic reminder of how powerful a
single percentage point can be.
The difference between 6.0 per cent and
7.0 per cent doesn t sound like much. But the
difference between doubling your money in
12 years versus doubling your money in 10.3
years sounds a lot more significant.
As a side note, the Rule of 72 assumes that
your money "compounds annually" a term
which means that once a year, your interest
gets added to your principal and the entire
amount is reinvested.
(Interest is the money you ve earned; prin-
cipal is the money you ve started with.)
The Rule of 72 is also a helpful tool to illus-
trate the power of compound interest.
The Rule of 115
The Rule of 115 is the corollary to the Rule
of 72. If you think that doubling your money
isn t good enough, then the Rule of 115 is for
you. This rule of thumb shows you how long
it will take to TRIPLE your money.
I bet you can guess how the Rule of 115
goes. Divide the interest rate by 115. This is
the amount of time it takes you to triple your
For example, if your money earns an 8.0
per cent interest rate, it will triple in 14 years
(115 divided by 8 equals 14.3.)
If your money earns a 5.0 per cent interest
rate, it will triple in 23 years (115 divided by
5 equals 23.)
Note that tripling your money is easier---in
some respects---than doubling your money. If
you re earning a 5 per cent interest rate, you ll
spend 14-and-a-half years trying to double
it, but only an additional nine years tripling
it. This, again, is thanks to the power of com-
pound interest. The more interest your money
earns, the more money will be working for
This assumes you reinvest the interest, rather
than spending it on some new clothes or
I told a friend about these rules once, and
she asked a fantastic question: how do I rein-
vest the interest? How do I know if I m already
doing that or not?
"If you re not getting a check or a payment
from your investments each year," I replied,
"you re probably reinvesting the interest."
Look at the page---or the computer screen---
where you buy your funds. You should see a
little box that says, "reinvest interest and div-
idends." That box will probably be there regard-
less of whether you re investing in mutual
funds, stocks, bonds or exchange-traded funds.
Check that box and then forget about it.
Wait 14 years. Watch your money triple.
Power of compound interest
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