Let’s talk about compounding and the 72 rule

What is compound interest and what does it have to do with my personal finance?

There is a saying that "many overestimate what they can achieve in a year but underestimate what they can achieve in 10 years".

This statement is so visibly true when we look at the impact of compound interest on our investments.

So what is this compound interest?

Compound interest refers to the growth in earnings on your investment (principal amount and interest) as time passes, where the amount earned is reinvested.

Here is a simple formula for compound interest.
A = P(1 + r)^t.
Where:
A = Compounded(accrued) Amount (principal + interest).
P = Principal amount (Initial amount invested).
r = Fixed annual interest rate in decimal.
t = Time Involved in years.

Illustration

Mr Ken invested N500,000 at the age of 25 for a fixed interest of 11%, and completely forgot about this without any further investment. 40 years later an excited Mr. Ken while searching through some old documents stumbles upon the investment documents. Imagine his shock on realizing how much was waiting for him after 40 years.

A= 500,000(1.11)^40
A whooping N32,500,433.65

Ok so we can argue back and forth about the impact of inflation on this amount, but the fact remains this could have just been used to purchase 1 or 2 fancy phones which will require replacement in a maximum of 2 years with nothing to show for it.

What is this 72 rule and why does it matter to my personal finance?

The 72 rule is a simple way to determine how long an investment will take to double, given a fixed annual rate of return (fixed interest rate).
By dividing 72 by the fixed annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to double.

Using our above example at 11% fixed interest, our N500,000 will double every;
72/11= 6.55 years. That is over 6 times(40/6.55)
500k*2=1,000K*2=2,000K*2=4,000K*2=8,000k*2=16,000K*2=N32,000K

…To be continued