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You know how people always say that the rich get richer? That’s because the rich understand how to create a long-term investment strategy.
To be honest, putting money into the stock market is the easy part. Just like what we saw with all the hype around GameStop. Sometimes you might be able to get REALLY lucky and make a couple quick-thousand dollars from trading.
But when it comes to investing, the real challenge is creating a long-term strategy that will establish yourself in the future.
This is the difference between trading and investing.
The world of Personal Finance is intricate and there are many strategies out there for long-term investing. Today we will be talking about the famous Rule of 72.
What is the Rule of 72?
The Rule of 72 is a simple formula that helps you determine how long it will take for an investment to double its value. And the good news is that you don’t need to be a math wizard to use it!
To use the Rule of 72, you need to know your average annual rate of return. If your annual rate of return is 7% you will simply divide 72 by 7.
72/7 = 10.2
This means that it will take 10.2 years for your investment to double.
“Voila.” It’s that simple. Now you have a tool that will help you figure out if an Index or an ETF that you are researching is worth the investment.
Double Your investment Every 7 Years
Did you know that if you make an investment in the S&P 500 your initial investment will double at an average of every 7 years? This is because the S&P 500 has an average annual return of 10%.
To some of you, 7 years may sound like a long time. But an investment in something like an ETF provides you with a more predictable rate of return rather than say a Tesla stock that fluctuates almost randomly throughout each year. This means that you can create a slower but more certain investment plan for your future.
You have probably heard of the stock indexes, NASDAQ, S&P 500, and Dow Jones Industrial. Stock Indexes are like baskets of stocks that contain the most reliable stocks on the market.
However, you can’t invest directly into the Stock Index. Instead, you must invest in something that mirrors an Index. This is because an Index is more like something that is on display that can be observed but not bought. So instead, you would purchase something like an ETF, or Index Fund, that is for sale and copies the contents of what’s in the basket of the stock index.
Here is an example:
Let’s say you are 24 years old and invest $5,000 into an ETF that mirrors the S&P 500. Just wait about 7 years and your investment will turn into $10,000.
Wait 7 more years and you’ll be 38 years old with $20,000 in your ETF investment.
Keep this up, and by the time you turn 60, you will have accumulated roughly $160,000 from your initial $5,000 investment.
Now, imagine if you had contributed $10,000 or more as your original investment instead of $5,000? Or even better, what if you started a few years earlier? Huge difference right?
You can see how important it is to plan for the long term. After all, nobody obtains financial freedom by accident.
Using ETFs to Double Your Investments
In addition to the rule of 72, the best way to maximize your earning potential is to reinvest your dividends and continue to contribute to your investment when you can.
ETFs are a great example of how you can begin to exercise The Rule of 72 because they mirror Stock Indexes. ETFs have low management fees, and they have a lower minimum investment rate compared to Index Funds. ETFs also trade like stocks which you are probably familiar with by now. This means that you can use your brokerage apps to invest in ETFs. Overall, an ETF is a good example of an investment that provides a consistent annual return and is accessible to everyone.
There are plenty of ETFs out there that you can choose from. But you can figure out which ones are reliable by simply looking at the history of their performance and applying their annual rate of return to our Rule of 72.
Some examples of high performing ETFs are:
ETFs that track S&P 500
SPY
VOO
SPDR
ETFs that track Dow Jones
DIA
ETFs that track NASDAQ
QQQ
Something to Keep in Mind
Naturally, over time your investments won’t strictly go up by the expected average annual rate of return every year. For example in 2002 the S&P 500 yielded a -22.2% return. But also gave a +28% return the following year in 2003.
It is important to understand that an average annual return is an AVERAGE. When committing to a long-term investment strategy you are bound to see ups and downs. Keep in mind that this is part of the process. The journey may be bumpy but you have to keep the end in mind.
This photo shows the past 2 decades of the Vanguard ETF (VOO). Vanguard ETF mirrors the S&P 500 and as you can see it does have ups and downs. You can even see where the stock market crashed at the beginning of the pandemic.
But, in the long run, Vanguard has proven to go up in value. That’s because it mirrors the S&P 500.
So as long as you make an educated investment all you will need to do from there is be patient, reinvest your dividends, and watch your investments grow as you get older.
Remember that the rule of 72 can be applied to any investment that provides an annual return. And at the end of the day you are making your own financial decisions and it is up to you to do the research. So you don’t have to apply this to an ETF if you don’t want to.
Do your own research and find what you want to invest in. Some possible investment opportunities that provide annual rates of return include but are not limited to Index Funds, Stocks, Bonds, Real Estate, REITs, and Pokemon cards!… Pokemon cards do NOT provide an annual rate of return. But they make for a fun hobby!
Bottom Line
The rule of 72 is a guideline that provides a general idea of what to expect in a long term investment. The rule of 72 does not take into account extra earnings such as dividends nor does it calculate expenses like taxes, or management fees.
So the rule of 72 should not be used as an end all be all formula. Rather, the Rule of 72 is a useful tool you can use to assess different ETFs or whatever investment plan you are researching. Use the Rule of 72 to plan out your goals and get started on a long-term plan.
Remember, nothing is ever 100% certain in the stock market. But you can make strategic long-term investments by continuing to educate yourself on the world of Personal Finance.
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