How to Motivate Your Kids to Save and Invest: The Rule of 72
Nothing illustrates the magic power of compounding like the Rule of 72, which estimates the number of years required to double your money.
It all began in 1988, the year of my 13th birthday, the year in which I was finally allowed to crack open my first ever piggy bank. This was no ordinary piggy bank. It was the size of a small dog, and was the recipient of 13 years of contributions from not only me, but also from family, friends and anyone else I could convince to feed him.
My 13th birthday was the first birthday that I did not care about opening a single present – I only wanted to crack open that pig! My excitement stemmed not from what I was going to be able to buy with the money, but rather, I wanted to find out what 13 years of savings looked like. In financial advisory language, I was curious about the “growth” of my money. Although, at the time, I did not fully understand that no real growth had actually taken place.
My “aha” moment for investing
Fast forward to the fall of 1993, my freshman year of college. This is the year I was first introduced to the Rule of 72. The Rule of 72 was definitely an “aha” moment for me. This was a moment that opened my eyes to the power of compound growth and what it means to save, and save early.
The Rule of 72 is a shortcut used to estimate the number of years required to double your money at a given annual rate of return. The rule states that you divide 72 by the rate, expressed as a percentage. For example, if an individual invested $100 today and earned 6% per year, it would take approximately 12 years for the $100 to become $200 (72 ÷ 6 = 12).
Turning $10,000 into $217,000
The Rule of 72 can be an extremely powerful tool for the younger members of our workforce who are just starting out. To illustrate, let us look at two individuals, Jane and Jack, who are both the same age. Jane started saving soon after her first job and accumulated $10,000 by the age of 25, and she never saved another penny the rest of her career. Jack on the other hand, started his savings program later — 10 years after Jane. But Jack invested a lump sum of $20,000 (double the amount Jane invested), and he too never saved another penny the rest of his career.
Both Jane and Jack earned a generous 8% per year on their investments, which means they doubled their money approximately every nine years. Who do you think had more money at age 65? Although Jack invested double the amount of Jane ($20,000 vs. $10,000), he ended up with $16,000 less than Jane, or approximately $201,000, while Jane’s money grew to approximately $217,000. By starting early, Jane was able to invest only half of what Jack invested, and still end up with more money — doubling her money more than four times during her career.
The bottom line for investors
Another important implied lesson of the Rule of 72, is that one must stay the course. The investment path to retirement is certain to have a few twists and turns along the way. However, in order to realize the full benefit of consistent, compound growth, one must remain invested through market ups and downs. A structured investment model must be developed and followed throughout one’s career. For those who consistently save and remain focused on the end goal — their retirement “piggy banks” will reward them.
If you have children just beginning their careers, you may want to share the Rule of 72 with them. It is a simple and easy-to-understand calculation to help get them excited about saving for their futures. As illustrated above, initiating an investment plan early can have a significant positive impact on their retirement savings. The Rule of 72 is one rule your kids will thank you for.
About the Author
Financial Adviser & Portfolio Manager, Baltimore-Washington Financial Advisors
Chris Kelly is a Certified Public Accountant (CPA) and a Certified Financial Planner™ (CFP®). He holds a B.S. in finance from the University of Maryland and a master's in accounting from George Washington University. Kelly assists clients with the implementation of their personal financial plans, investment tax strategy and overall financial risk management. He takes great pride in maintaining a relationship based on trust, transparency and accountability with each of his clients.