Power of Compound Interest – NationNews Barbados – nationnews.com

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Louise Fairsave

Today, let’s go back to the table below: column 1 indicates the year of the investment return, column 2 presents the balance of the investments at the end of the year concerned when $5,000 is invested at a rate of 10% simple interest, column 3 represents the balances per year for the same investment at 10% compounded annually, column 4 presents the difference in income between simple and compound income at 10% and column 5 presents the results if the investment were compounded annually at 12%.

This chart was used to explain the interest rule of 72. This rule applies to compound interest and says that “the interest rate on an investment ‘R times’ the number of years for your investment to double of value” T is equal to 72: RXT = 72 or: T = 72/R or R = 72/T.

As shown in the table, column 3, at 10%, the $5,000 investment would take approximately 72/10 = 7.2 years to double. Alternatively, if the goal is to double the $5,000 investment in 6 years, the ROI should be around 72/6 = 12%, reference column 5.

This rule also works to assess the fall in value of money over time given the rate of inflation. For example, $5,000 will drop to half its value, or $2,500 in 24 (72/3) years at an inflation rate of 3%. Although inflation rates tend to fluctuate over long periods of time, it is very important to recognize the decreasing effect of inflation on interest income.

The accuracy of this rule becomes increasingly blurred as interest rates rise, say 20%. However, the ruler is extremely useful for quick assessments of typically daily interest rate levels. The necessary calculations can mainly be done mentally.

The most accurate rule is the 69.3 rule, sometimes simplified to the 70 rule. Using 69.3 would give more accurate results at any interest rate. However manipulating this number mentally is a greater burden. Still, using the 69.3 rule is a shorter and less complex approach than the exponential and logarithmic mathematical calculation that would be required to get the exact result down to the last two decimal places.

Finally, the rule of 114 provides a similar quick estimate of how long it takes to triple your money at a particular interest rate: RXT = 114. I’ll let you check this rule using column 5. These rules allow you to assess the amazing effects of compound interest to fuel your financial plans.

• Louise Fairsave is a Personal Money Advisor, providing practical advice on money and estate matters. His advice is general in nature; readers should seek advice on their particular situation. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.

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