Do you want to get the green light to take more elaborate vacations or indulge more with little to no consequence? Does buying a daily $6 cup of coffee even impact our wealth? It all starts with learning what the rule of 72 is. The rule of 72 can show you the consequences or lack of consequences of making a significant purchase. It's all about giving yourself an extra treat when the time is right. Too many people say the word save, but when can we spend and how much? When should spending be guilt-free? It becomes clearer by understanding the rule of 72 and how to use it as a tool.

The rule of 72 is a ballpark estimate; it suggests you can double your money every time you compound your investment returns and get 72%. For example, if your investment averaged a 10% return over 7.2 years, your original investment would have doubled (10x7.2=72). If you earned 3% each year, it would take 24 years to double (24x3=72). In these examples, we assume the returns are net of fees and are in a tax-free retirement account.

I like to tell clients' children about the rule of 72 to emphasize the power of compounding. Just imagine a young adult who has turned 20 and is given the gift of $30,000 from their parents. As a youngster still learning life skills, it's only natural to want to spend. After all, retirement is so far away that it feels like it doesn't matter.

By learning how compounding returns works, these young adults can quickly understand the consequences of spending now versus later. I like to say knowledge is power. And what could be more informative than doing a quick and easy cost-benefit analysis on every decision you make? Are there any real consequences when a young adult buys a new car versus used or pays a few extra dollars for more luxury? Let's find out. 

As of the end of May 2024, an investment product called iShares Core S&P 500 ETF, which closely follows the US S&P 500 Index, annualized over 12% over the past ten years and over 14% over the past 15 years. The S&P 500 has had a substantial run, but it would be reasonable to assume the S&P could earn at least 10% on average each year over the next 30 to 40 years. The 10% assumption makes using the rule of 72 more straightforward. By assuming an average return of slightly more than 10%, we do not need a calculator to start calculating; we can calculate that for every seven years, your investment will double in size. So, to use the rule, you only need to know multiplication and how to count your fingers. 

Imagine your 20-year-old child has an extra $30k ready to spend on a car. They have the power to make a life-changing decision. They must decide whether to buy a new or used vehicle and invest in the difference. If they are feeling overwhelmed, the following may help.

If we keep our 10%+ stock market return assumption, the child would have $60k+ in the first seven years if they invested their $30k instead of spending. Since we hit 72 (7x10%+), it doubled. One million dollars still seems far away or nearly impossible. To make more sense, start counting your fingers. When you touch your first finger, say $60k, double the number at the next finger, double it again at the third finger, and continue. So, as we start counting, $60k, $120k, $240k, $480, and subsequent $960k. For simplicity, let's round to $1 million; if the next  15 years resemble the past, we have already far exceeded one million dollars. If you counted your fingers, five would be showing. Each finger represents seven years, and five times seven is thirty-five. At about a 10% return on average for the next thirty-five years, $30K becomes one million. So, a 20-year-old's decision to invest $30k and not invest any new money can result in them becoming a millionaire in their mid-50s. So, that one-time splurge in your 20s might be the reason why you are not a millionaire. 

The time value of money shows the damage spending can do in our young adult years, but it also lets us know when we can splurge a little. The rule of 72 works both ways. For example, once we reach age 70, most prefer to decrease risk, so we do not aim for a 10% return or higher. Instead, we might aim for a more conservative figure of close to 7%. Or, if you are catching on, let us call it 7.2%. With some simple math, 7.2 times ten is seventy-two. So, by following the rule of 72, if we earn a return close to 7.2% each year, our investment will double every ten years. If you decide to buy a new car at age 70 for $50k, you would need to live at least ten more years to see that money become $100k. While it's nice to see the money grow, I would expect it to generate less than one million any time soon, so you might have a good excuse to splurge a little. If you have enough money to live on, it's time to enjoy life a little more! If you are considering splurging a lot, consider a retirement plan to see if it compromises your future lifestyle. >>Learn About Retirement Plans With Our Find & Fix Service.

Now, how about the six-dollar daily coffee budget? Six dollars a day is close to $2,000 a year. When you compound one year of spending over five doubling periods, the damage is about $64,000 yearly for every year you keep the habit. If you started the habit at age 20 by your mid-50s, you would be down $64,000 yearly if you kept your routine. It isn't a million-dollar damage until ten doublings, which is 70 years, 10% plus return. If coffee makes you happy, it's time to enjoy a cup and watch those big purchases closely.

Would you like some help investing?>>Click Here To Learn About Our Investment Management