The rule of 72
A quick way to measure the power of saving and the effects of inflation.
The rule of 72 allows you to find approximately how many years it will take you to double the value of your investment. Quite useful if you want to work out what your pension will be worth 20 years from now and you haven’t got a degree in maths.
It’s not precise, because to work it has to assume an average growth rate over the whole period.
Let’s say, just to make the maths simple, we assume a growth rate of 7% a year.
Take 72 and divide it by 7. Your investment will double in just over 10 years. That is, an investment of £10,000 will become £20,000 in around 10 years time, and after another 10 years will have doubled again to £40,000.
If you had kept it invested for over 30 years (3 x 10 years), the sort of time span that most pensions run for, your investment will be worth £80,000. An eight-fold return on the original investment.
And while you might find the initial contribution of £10,000 a bit steep, remember that most people keep putting money into their pensions year after year, so potentially your pension pot could be a whole lot larger.
The secret here is time. Simply put the longer you can leave your savings and investments to grow the better off you will be.
But what about the effects of tax and inflation. True, these can have a major effect on your savings, which is why it is important to find a tax-free savings vehicle which earns interest or investment returns tax-free.
Here again, you can calculate the length of time it will take for inflation to halve the real value of your money.
Again, assume an average inflation rate of 3% - that’s just about the rate it’s currently running at. Divide 72 by 3, and you can quickly see that the purchasing power of your money would halve in 24 years.
Hmm, that means your very substantial pension pot of £80,000 would be worth less than £40,000. So, as you can see that even at the low rates we have been enjoying in recent years, inflation has a profound effect on long term savings. And sadly, the only answer is to save more.
