Learn what the rule of 72 is and how you can use it to estimate how long it will take you to double your investment.
Sometimes I explain math concepts that you might think you won’t really use in the real world. But not today—because today’s topic has to do with money! There are many ways to make money, but the easiest way is to invest the money that you already have and allow it to make you more money by earning interest. But what does that really mean? And how fast does it work? Well, the answers to those questions depend upon a couple of factors. Once you know what those factors are, finding the answer is surprisingly easy. As we’ll talk about today, the trick that you need to know is called “the rule of 72.”
SPONSOR: http://stitcher.com/math. Use the code “math” to be entered to win $100.
What Does It Mean to Earn Interest?
I’ll leave it to Money Girl to explain most of the ins-and-outs of the various ways in which you can earn interest on your money, but there are a couple of basics that we should go over before going any further. First, what is interest? Well, when you make an investment—such as putting money into a bank savings account—the bank pays you in exchange for you letting them temporarily use your money. That money the bank pays you is interest, and the amount of interest you earn is usually paid out every year as some percentage of the total amount of money you’ve invested.
For example, right now the interest on a typical savings account is somewhere around 1% per year. That means that if you have $1000 invested in this savings account, you will earn 1% of $1000 or 0.01 x $1000 = $10 in interest the first year. After that year, your account will have a total of $1000 + $10 = $1010 in it. The next year, you’ll again earn 1% interest (unless the rate has changed), but instead of earning that 1% interest on $1000, this time you’ll earn it on $1010. So, in the second year you’ll earn 1% of $1010 or 0.01 x $1010 = $10.10, for a grand total of $1010 + $10.10 = $1020.10. That type of interest where you make money on the interest you’ve already earned year after year is called compound interest—we’ll talk more about it next week.