The rule of 72 is methods for estimating an investment’s doubling time. In another words, it is a measurement of how many years it will take your money to double given a fixed annual rate of interest.
To estimate the number of periods required to double an original investment, you divide the 72 by the expected growth rate, expressed as a percentage. The rule is expressed in this very simple equation: 72 / interest = No. of years it takes for your money to double
For example, using the Kaupthing Edge fixed term deposit rates of 7.01 AER (as of 16/june/2008) as our fixed annual rate of interest. A cash deposit of £1000 in their savings account will take (72/7.01 = 10.2) 10.2 years to double in value. So an initial £1000 investment will be worth £2000 in 10.2 years.
So after 20.4 years a deposit of £1000 will be worth £3000 and after 30.4 years your investment with be worth £4000. However the drawback of using the rule of 72 is that it does not take into consideration the inflation of an economy. Inflation is the rate of increase in the level of prices for goods and services, which affects the purchasing value of money. Between the years when the cash is deposited and when it is taken out of the account, inflation can builds up and starts to corrode the savings.
Any type of investing can pose a risk. Unless you are investing in a savings account (secured with insurance by the government) or you are not guaranteed that your original principal (the amount of money you originally invested) is going to be protected. Investments in a savings account usually produce a much lower return than investments in risky assets such as stocks and share.
The key to making good returns on with riskier investments such as investing in shocks and shares is to diversify your investments. Before you begin to diversify your stock portfolio, it’s important to make absolutely sure that you know what diversity is. Diversification means creating an investment portfolio that contains different types of investments within each of the major asset classes — stocks, bonds, and cash.
Diversification isn’t just about increasing the sheer number of your investments. It’s about striking a balance among various investments in your portfolio to reduce your exposure to risk and take advantage of the full range of opportunities in the market. With diversification you will almost be certain that some asset classes will being well when other asset classes are not doing well.
The easiest way to diversify your investments is choose mutual funds. All funds own a number of investments, and some funds spread their investments broadly within an asset class, owning stocks or bonds of different sized companies in different industries or sectors. Provided the fund isn’t too narrowly focused, it may provide you with ready-made diversification.
Besides mutual funds, it’s usually a good idea to buy some short-term investments such as CDs and money market funds as well. This is because you not only want to diversify within a certain asset class (in this case, mutual funds or stocks), but you also want to Diversify across time horizons for further diversification.
No mater the type or situation of your investments diversification is still important so that you investments as a whole will be protected and less at risk than they would be if they were not so diversified.
