Editor’s note: This article was first published in March 2013. The example of fixed-term deposits paying 5% APR reflects Spanish rates around 2013.
One way to reach a financial goal is to set yourself realistic targets. Sometimes, though, setting realistic targets can be demotivating because of the time involved.
In financial education, as in investing, we need to be somewhat patient. (Read: Which investments are most profitable for reaching financial freedom?) Once we know what type of investment we are going to choose, we can use a few small math tricks to get a clear picture of all the factors, including time. I hope these simple mathematical rules help you.
1. The rule of 72
How long will it take to double the money you invest?
Just divide 72 by the return you want or expect, and the result is the number of years it will take to reach your goal. In other words, if we expect to earn 10% a year on our investments, it would take us 7.2 years to double the money we invested.
If fixed-term deposits paying 5% APR are more our thing, it would take us 14.4 years (72 ÷ 5 = 14.4) to turn €10,000 into €20,000.
2. The rule of 115
If, on the other hand, what you want is to triple your investment, take 115 and divide it by the expected return. If we expect to earn 10% a year, it would take us 11.5 years to triple our money. If our expected gain is 5% a year, it would take us 23 years to triple our money.
3. The rule of 70
This one is useful for working out how long it will take inflation to cut our money in half. In other words, because of inflation, 1 euro or dollar today will at some point be worth only 50 cents. Just divide 70 by the expected inflation rate. If we expect inflation to run at 3% a year, we divide 70 by 3, which gives us 23.3.
Put another way: if we stuff €10,000 under the mattress and don’t invest it, in 23 years it would be as if we had only €5,000. You need to apply this rule on top of the previous ones to discount your gains. Of course, in the stock market the opposite usually happens: appreciation, which in theory beats inflation, provided we have picked a good company, naturally.
4. The number 2
How much is an hour of your time really worth? This is ideal for working out whether we need to put in more overtime. Sometimes, once this figure has been worked out, it can be rather depressing for some people, so you need to make the most of those hours, even if it’s through other kinds of income (passive income).
Take your annual salary, knock off the last three digits and divide by 2. The result is what you earn per hour (based on a 40-hour working week). In other words, if we earn €40,000 a year, we knock off the three zeros and divide by 2: we earn €20 per hour worked. If, on the other hand, our salary is €15,000 a year, we would earn €7.50 an hour. The problem for working people is what happens when they do the real maths: they usually put in more than 40 hours a week, plus the time spent getting to and from work, minus transport costs and so on. In the end, a high percentage of the population earns an average of €3 an hour, and that way nobody gets rich 🙂
5. The golden rule of personal finance: the number 120
This is a calculation used by the best financial advisers all over the world. It tells you, based on your age, how much of your money you should have in stocks and how much in fixed income. Subtract your age from 120. The result is the percentage of your capital you should put into equities.
In other words, if you are 50, you should have 70% of your money in equities (stocks) and the other 30% in fixed income. Interestingly, if you are 20, this rule says you should have 100% in stocks.
When people are young is when they should take on more risk with their investments, since if things go wrong, we assume they will have time to recover and learn.
That said, I always advise that while you are still saving or building an emergency fund, you start with a couple of years in fixed income, unless you catch the market just after a fall and see things very clearly.
Some people say the worst thing that can happen when you’re learning to invest is to make a lot of money on your very first investment, because then you don’t learn. Believe me, there’s nothing better than losing your stock market virginity, so to speak, with a generous capital gain, as long as you keep learning. You go ahead and win; there’s always time for losing.
“There’s nothing wrong with winning, and there’s nothing wrong with losing either, as long as you don’t get used to it.”
I hope these simple calculations help you.
Further reading
Featured image: Pittigrilli, CC0 1.0, via Wikimedia Commons.
