Monday, September 26, 2016

Doubling Up

The Rule of 70 is a simple way to figure out roughly how long some money will take to double in value. If you invest $1,000 and receive 5% return, it will double in roughly (70/5) 14 years. It actually would take just over 15 years, but if you are making a quick calculation, you don't have to be exactly right. (Another example at 10%, the Rule of 70 estimates 7 years.) 

In the first year you earn 5% on $1000.  $50. In the second you earn 5% on $1,050. $52.50. So earn money on the growth as well. This is compounding. In the 15th year, just before the 'doubling event', the amount being earned will also have doubled to $94.28.

Long periods of time are very powerful when it comes money. There is a story of a wise man who helped the Chinese Emperor. The Emperor said he could have anything he wanted in return. He asked for a chess board to be laid down. He wanted one grain of rice for the first square. Two grains for the second square. Four for the third. For each of the 64 squares of the chess board, he would like the process to be repeated. The Emperor agreed, bemused that he had requested such a small gift.

On the 33rd square, there would have been over 4 billion (4,294,967,296) grains of rice. That is only the start of the second half the chess board. The Emperor had given the wise man his empire without knowing it.

That is the problem with Debt. It is cunning. The same compounding that works for investing, also works for borrowing. You pay interest on interest. This is where the Biblical seven year forgiveness on debt comes from. In a short period of time, there is some connection between what is being borrowed, and what is being paid. As the repayment period gets longer, what you are really borrowing is money to pay interest on the interest.

Besides the 'Rule of 70', another good rule of thumb is 'Save for what you want, don't borrow and spend'. Good Debt is when the money is put to work, so it makes more than the interest it needs (the money's salary). Bad Debt just digs holes. 

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