Why Every Millennial Must Learn the Rule of 72
Millennials listen up–pay attention to this Struming. It may be the most important financial advice you’ll ever get. Understand the Rule of 72, save as aggressively as you can in an IRA and/or a 401(k), and then watch your dollars grow exponentially.
What is the Rule of 72?
It’s how quickly money doubles. You simply divide the rate of growth into 72.
At 4% money doubles every 18 years (72 divided by 4)
At 6% money doubles every 12 years (72 divided by 6)
At 8% money doubles every 9 years (72 divided by 8)
And so on.
It works. Trust me. Want to spend 10 minutes doing the multiplication. Do it and you will get the same answer.
How does this relate to savings?
Money saved today compounds to many more dollars in the future.
For example, just $5000 saved by a 25-year-old today invested in equities yielding 8% annual growth (the avg. rate of growth in the S&P 500 over time) would grow to $160,000 by the time he/she was 70. That’s a 32 multiple of their initial investment.
As I look back on my 20s I realize that I had little vision of what life would be like today or the importance of saving. Who could have? There were no IRAs or 401(k)s back then and many companies still had pension programs and profit sharing. The world has changed so much in the past 40 years, but we could say the same for every 40-year increment in recent history. However, it is so hard for any recent grad to look over the horizon and think about things like retirement, social security, long term health care, etc. Current grads are understandably worried about getting a first job and paying off college loans.
However, one thing has not changed over the years, and in fact has become far more important for today’s Millennials:
Saving
Most Millennials don’t really get the importance, despite the fact personal finance is so important for Millennials to learn and embrace. Saving for the future is more critical than ever for Millennials for 3 important reasons.
1.Pensions virtually no longer exist, and employment for life is a pipe dream.
Millennials need to manage their careers as if they were a “one-man brand” (because they are).
2.The majority of Millennials believe that Social Security will not be there for them in the future.
That may be overstated; however, it will be tweaked for sure, and they are wise to think about other means of financial support in the future.
3. They will live far longer.
The average life expectancy for a 25-year old male is 86 years and for a 25-year old female is 90 years. As a result, Millennials will “enjoy” greater longevity yielding far more golden years later in life.
But the triple whammy of these 3 factors can yield a disastrous future for those who do not prepare.
However, Millennials have time, the most powerful financial ally if used properly. Here’s a simple example of the power of time and compounding:
First a 25-year old needs to save $2,000/year in a 401(k) or IRA and then increase the contributions to $4,000 annually at age 35, $6,000 annually at age 45 and $8,000 by age 55, and then needn’t contribute beginning at 65 and beyond. Then most importantly, they need to never touch these funds and pay needless, costly penalties for doing so.
If these funds were invested for growth delivering 8% compounded annual appreciation, the account would yield nearly $1.4 Million when they turn 70. And it could continue to grow beyond 70 as well. That’s the Rule of 72 in action.
On top of this you can increase this amount with a company match and additional savings in peak earning years beyond this example. Creating a nest egg of $2 Million or more is not a stretch for those with the discipline and vision to save young, early and often.
However, the key is to start saving at a young age. While saving $2,000 annually ($167/month) is not pocket change for a 25-year old, it is merely $5.50 per day. Delete the Starbucks, the extra drink on Saturday night, and scale back the vacation and the savings should be easy. If you’re employed, then just fund your 401(k) through payroll deduction without fail. And use a Roth 401(k), if possible, which won’t give you any tax savings in the short term, but will pay big dividends in appreciation without tax in the long term. In the example above, only $200,000 was contributed by the individual during a 40-year period and an additional $1.2 Million (at the 8% growth example) was all appreciation. And all of those dollars are TAX FREE, not taxed at your ordinary income rates when withdrawn, if contributed to a Roth.
So, $200,000 of savings yields $1.4 Million. A penny saved is 7 pennies earned!
Millennials need to do whatever it takes to save. If they do, and respect the power of the Rule of 72, they can be the beneficiary of substantial wealth later in life. However, if they don’t save, their later years will be painful financially. Choice is theirs.
More Strumings
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- It’s All Over.
- A DJ Once More.
- States Rights and States Responsibilities.
Lonny,
The single best read I have ever seen for a young person starting their professional career. Thank you!!!!!
Rich
Thanks Rich