Compound Interest and The Rule of 72

Compound Interest and The Rule of 72

June 14, 2022
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Often when people leave one employer to start a new employment chapter of life, they are tempted to withdraw the money from their retirement account and spend it.  In certain situations, perhaps that is necessary, but, if possible, I strongly urge you to leave the money in the retirement account to continue to grow and compound upon itself. 

Albert Einstein, a pretty smart man, said, “The most powerful force in the universe is compound interest.”  He called compound interest, the “Eighth Wonder of the World.” 

The Rule of 72, as some of you may recall, tells us how many years are required for an investment to double by dividing the interest rate into 72.

Let’s look at what compound interest can do in a tax-deferred investment account such as a 401-k plan or an IRA.  If you assume that retirement account is invested in a large cap equity fund, which historically has averaged about 10% a year, then dividing that 10% interest rate into the number 72, comes out to be about 7. Thus the account doubles every 7 years.

Let’s say you have $10,000 saved in your retirement account.  Assume you are 30 years old and planning to retire at age 65.  That’s 35 years from now and that is five, seven-year intervals.  That means in the retirement account, with no taxes being withdrawn from the compounding investment, that your $10,000 will double, five times, between 30 and 65.

Example:

  1. $10,000 grows to $20,000
  2. $20,000 grows to $40,000
  3. $40,000 grows to $80,000
  4. $80,000 grows to $160,000
  5. $160,000 grows to $320,000

The moral of the story: Dollars in your retirement account today, are the most powerful of all the dollars that will ever be in your account.  Try your best to leave those dollars in your account and then roll the account to your next employer’s plan.  This will greatly increase your chance of retirement income success.

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