Einstein discovered the ‘Rule of 72,’ which basically means that if you divide 72 by the interest rate you are receiving you will know how many years it will take to double your money.
At 8% interest per annum it will take 9 years to double your money – i.e. 72 divided by 8 equals 9. The reverse also works. If you want to double your money in say 5 years then divide 72 by 5 and you will find out that you will need to earn 14.4% return on your money, compounded annually. What this illustrates is that either a high interest rate or a long period of time will result in rapid doubling and thus yield big results with compounding. When the two are combined the impact is dramatic.
As any investor knows, however, high rates of return are elusive and can’t just be conjured up out of thin air. However, for the Child Millionaire portfolio, while we can’t control the rate of return, we have the inherent advantage of lots and lots of time. Not enough time to squander it, but enough to turn almost any amount of money into a fortune.
The Power of Time and Compounding
Unlike middle-aged people investing for their retirement, with say 15 or 20 years to go, a newborn, who statistically is likely to live well into her 80s or beyond, has the advantage of 40, 50, 60 or more years on her side for a portfolio to grow. This time side of the compounding formula can create truly staggering outcomes. Using the historic long-term rate of return on stocks of 8.92% compound annual growth rate before inflation, here is what would happen to $1,000 invested when a baby is born.
Future value of $1,000 earning 8.92% compounded annually
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