1 00:00:00,000 --> 00:00:08,220 2 00:00:08,220 --> 00:00:11,390 In the last video, we talked a little bit about compounding 3 00:00:11,390 --> 00:00:15,480 interest. Our example was interest that compounds 4 00:00:15,480 --> 00:00:17,830 annually, not continuously like we would 5 00:00:17,830 --> 00:00:18,790 see in a lot of banks. 6 00:00:18,790 --> 00:00:21,390 I'll really just wanted to let you understand that although 7 00:00:21,390 --> 00:00:22,290 the idea is simple. 8 00:00:22,290 --> 00:00:25,040 Every year you get 10% of the money that you started off 9 00:00:25,040 --> 00:00:25,650 with that year. 10 00:00:25,650 --> 00:00:28,720 And it's called compounding because the next year you get 11 00:00:28,720 --> 00:00:31,900 money not just on your initial deposit, but you also get 12 00:00:31,900 --> 00:00:35,300 money or interest on the interest from previous years. 13 00:00:35,300 --> 00:00:37,470 That's why it's called compounding interest. And 14 00:00:37,470 --> 00:00:40,290 although that idea is pretty simple, we saw that the math 15 00:00:40,290 --> 00:00:41,420 can get a little tricky. 16 00:00:41,420 --> 00:00:44,950 If you have a reasonable calculator, you can solve for 17 00:00:44,950 --> 00:00:46,870 some of these things if you know how to do it. 18 00:00:46,870 --> 00:00:50,550 But it's nearly impossible to actually do it in your head. 19 00:00:50,550 --> 00:00:53,640 For example, at the end of the last video, we said if I have 20 00:00:53,640 --> 00:00:54,700 a hundred dollars. 21 00:00:54,700 --> 00:00:57,860 And if I'm compounding at 10% a year, that's where this 1 22 00:00:57,860 --> 00:01:01,350 comes from, how long does it take for me to double my money 23 00:01:01,350 --> 00:01:02,910 and end up with this equation? 24 00:01:02,910 --> 00:01:06,420 And to solve that equation, most calculators don't have at 25 00:01:06,420 --> 00:01:08,110 log base 1.1. 26 00:01:08,110 --> 00:01:09,970 And I've shown this in other videos. 27 00:01:09,970 --> 00:01:15,050 This you could also say, x is equal to log base 10 of 2, 28 00:01:15,050 --> 00:01:18,610 divided by log base 1.1 of 2. 29 00:01:18,610 --> 00:01:23,900 This is another way to calculate log base 1.1 of 2. 30 00:01:23,900 --> 00:01:27,620 This should be log base 10 of 1.1. 31 00:01:27,620 --> 00:01:29,290 I say this because most calculators have 32 00:01:29,290 --> 00:01:30,700 a log base 10 function. 33 00:01:30,700 --> 00:01:32,620 And this and this are equivalent. 34 00:01:32,620 --> 00:01:34,320 I've proven it in other videos. 35 00:01:34,320 --> 00:01:36,400 So in order to say how long does it take to double my 36 00:01:36,400 --> 00:01:38,020 money at 10% a year? 37 00:01:38,020 --> 00:01:39,690 You'd have to put that in your calculator. 38 00:01:39,690 --> 00:01:41,860 And let's try it out. 39 00:01:41,860 --> 00:01:43,210 Let's try it out right here. 40 00:01:43,210 --> 00:01:46,030 We're going to have, 2, and we're going to take the 41 00:01:46,030 --> 00:01:56,090 logarithm of that, 0.3, divided by 1.1, and the 42 00:01:56,090 --> 00:01:57,950 logarithm of that. 43 00:01:57,950 --> 00:02:00,440 We close the parentheses. 44 00:02:00,440 --> 00:02:03,710 Is equal to 7.27 years. 45 00:02:03,710 --> 00:02:06,350 Roughly 7.3 years. 46 00:02:06,350 --> 00:02:10,410 So this is roughly equal to 7.3 years. 47 00:02:10,410 --> 00:02:13,280 As we saw in the last video, this is not necessarily 48 00:02:13,280 --> 00:02:16,220 trivial to set up, but even if you understand the math here, 49 00:02:16,220 --> 00:02:18,590 it's not easy to do this in your head. 50 00:02:18,590 --> 00:02:20,720 It's literally almost impossible to do in your head. 51 00:02:20,720 --> 00:02:23,640 So what I want to show you is a rule to 52 00:02:23,640 --> 00:02:25,400 approximate this question. 53 00:02:25,400 --> 00:02:29,000 How long does it take for you to doubles your money? 54 00:02:29,000 --> 00:02:34,060 And that rule is called the rule of 72. 55 00:02:34,060 --> 00:02:37,380 Sometimes it's the rule of 70 or the rule of 69. 56 00:02:37,380 --> 00:02:41,350 But rule of 72 tends to be the most typical one, especially 57 00:02:41,350 --> 00:02:43,900 when you're talking about compounding over 58 00:02:43,900 --> 00:02:45,000 set periods of time. 59 00:02:45,000 --> 00:02:46,590 Maybe not continuous compounding. 60 00:02:46,590 --> 00:02:49,670 Continuous compounding you'll get closer to 69 or 70. 61 00:02:49,670 --> 00:02:51,690 But I'll show you what I mean in a second. 62 00:02:51,690 --> 00:02:57,250 So to answer that same question, let's say I have 10% 63 00:02:57,250 --> 00:02:58,500 compounding annually. 64 00:02:58,500 --> 00:03:06,990 65 00:03:06,990 --> 00:03:10,470 Using the rule of 72, I say how long does it take for me 66 00:03:10,470 --> 00:03:11,740 to double my money? 67 00:03:11,740 --> 00:03:16,500 I literally take 72, that's why it's called the rule of 68 00:03:16,500 --> 00:03:18,570 72, I divide it by the percentage. 69 00:03:18,570 --> 00:03:20,780 So the percentage is 10. 70 00:03:20,780 --> 00:03:22,780 It's decimal representation is 0.1. 71 00:03:22,780 --> 00:03:25,460 But it's 10 per 100 percentage. 72 00:03:25,460 --> 00:03:27,490 So 72 two divided by 10. 73 00:03:27,490 --> 00:03:33,380 And I get 7.2, it was annual, so 7.2 years. 74 00:03:33,380 --> 00:03:35,680 If this was 10% compounding monthly, it 75 00:03:35,680 --> 00:03:37,320 would be 7.2 months. 76 00:03:37,320 --> 00:03:42,210 So I got 7.2 years, which is pretty darn close to what we 77 00:03:42,210 --> 00:03:44,910 got by doing all that fancy math. 78 00:03:44,910 --> 00:03:47,460 Similarly, let's say that I'm compounding-- 79 00:03:47,460 --> 00:03:49,230 let's do another problem. 80 00:03:49,230 --> 00:03:55,420 Let's say I have 6% compounding annually. 81 00:03:55,420 --> 00:04:04,370 82 00:04:04,370 --> 00:04:11,020 Using the rule of 72, I just take 72 divided by the 6. 83 00:04:11,020 --> 00:04:14,465 And I get 6 goes into 72, 12 times. 84 00:04:14,465 --> 00:04:19,060 So it'll take 12 years for me to double my money, if I'm 85 00:04:19,060 --> 00:04:22,350 getting 6% on my money compounding annually. 86 00:04:22,350 --> 00:04:23,570 Let's see if that works out. 87 00:04:23,570 --> 00:04:26,530 So we learned last time, the other way to solve this would 88 00:04:26,530 --> 00:04:30,490 literally be, we would say x, the answer to this, should be 89 00:04:30,490 --> 00:04:38,310 close to log base anything of 2 divided by-- this is where 90 00:04:38,310 --> 00:04:41,150 we get the doubling our money from, the 2 means 2 times our 91 00:04:41,150 --> 00:04:45,880 money-- divided by log base whatever this is 10 of. 92 00:04:45,880 --> 00:04:49,780 In this case instead of 1.1 it's going to be 1.06. 93 00:04:49,780 --> 00:04:52,270 So you can already see it's a little bit more difficult. 94 00:04:52,270 --> 00:04:54,460 Get our calculator out. 95 00:04:54,460 --> 00:05:04,770 So we have 2, log of that, divided by 1.06, log of that, 96 00:05:04,770 --> 00:05:08,680 is equal to 11.89. 97 00:05:08,680 --> 00:05:10,500 So about 11.9. 98 00:05:10,500 --> 00:05:14,540 So when you do all the fancy math, we got 11.9. 99 00:05:14,540 --> 00:05:17,330 So once again you see this is a pretty good approximation, 100 00:05:17,330 --> 00:05:22,720 and this math is much simpler than this math. 101 00:05:22,720 --> 00:05:25,300 And I think most of us can do this in our heads. 102 00:05:25,300 --> 00:05:27,960 So this is actually a good way to impress people. 103 00:05:27,960 --> 00:05:31,890 And just to get a better sense of how good this number 72 is, 104 00:05:31,890 --> 00:05:35,690 what I did is I plotted on a spreadsheet. 105 00:05:35,690 --> 00:05:38,760 I said, OK, here's the different interest rates. 106 00:05:38,760 --> 00:05:41,180 This is the actual time it would take to double. 107 00:05:41,180 --> 00:05:45,340 So I'm actually using this formula right here to figure 108 00:05:45,340 --> 00:05:48,900 out the precise amount of time it'll take to double. 109 00:05:48,900 --> 00:05:52,790 Let's say this is in years if we're compounding annually. 110 00:05:52,790 --> 00:05:55,190 So if you're at 1%, it'll take you 70 years 111 00:05:55,190 --> 00:05:55,980 to double your money. 112 00:05:55,980 --> 00:05:59,460 At 25% it'll only take you a little over 3 years to double 113 00:05:59,460 --> 00:06:00,710 your money. 114 00:06:00,710 --> 00:06:02,960 115 00:06:02,960 --> 00:06:10,870 This is the correct-- and I'll do this in blue-- 116 00:06:10,870 --> 00:06:11,970 number right here. 117 00:06:11,970 --> 00:06:13,220 So this is actual. 118 00:06:13,220 --> 00:06:19,570 119 00:06:19,570 --> 00:06:21,310 And I plotted it here, too. 120 00:06:21,310 --> 00:06:24,450 If you look at the blue line, that's the actual. 121 00:06:24,450 --> 00:06:26,140 I didn't plot all of them. 122 00:06:26,140 --> 00:06:28,600 I think I started at maybe 4%. 123 00:06:28,600 --> 00:06:32,560 So if you look at 4%, it takes you 17.6 years 124 00:06:32,560 --> 00:06:33,370 to double your money. 125 00:06:33,370 --> 00:06:37,360 So 4%, it takes 17.6 years to double your money. 126 00:06:37,360 --> 00:06:39,450 So that's that dot right there on the blue. 127 00:06:39,450 --> 00:06:46,270 At 5% percent, it takes you 14 years to double your money. 128 00:06:46,270 --> 00:06:48,200 And so this should also give you an appreciation that every 129 00:06:48,200 --> 00:06:50,780 percentage really does matter when you're talking about 130 00:06:50,780 --> 00:06:54,490 compounding interest. When it takes 2%, it takes you 35 131 00:06:54,490 --> 00:06:55,310 years to double your money. 132 00:06:55,310 --> 00:06:57,490 1% takes you 70 years. 133 00:06:57,490 --> 00:07:00,900 You double your money twice as fast. It it really is 134 00:07:00,900 --> 00:07:02,680 important, especially if you think about doubling your 135 00:07:02,680 --> 00:07:05,230 money, or even tripling your money for that matter. 136 00:07:05,230 --> 00:07:13,200 Now in red, I said what does the rule of 72 predict? 137 00:07:13,200 --> 00:07:17,280 So if you just take 72 and divided it by 1%, you get 72. 138 00:07:17,280 --> 00:07:21,730 If you take 72 divided by 4, you get 18. 139 00:07:21,730 --> 00:07:25,100 Rule of 72 says it'll take you 18 years to double your money 140 00:07:25,100 --> 00:07:27,580 at a 4% interest rate, when the actual 141 00:07:27,580 --> 00:07:30,520 answer is 17.7 years. 142 00:07:30,520 --> 00:07:31,420 So it's pretty close. 143 00:07:31,420 --> 00:07:34,455 So that's what's in red right there. 144 00:07:34,455 --> 00:07:37,490 145 00:07:37,490 --> 00:07:38,820 So I've plotted it here. 146 00:07:38,820 --> 00:07:40,680 The curves are pretty close. 147 00:07:40,680 --> 00:07:45,510 For low interest rates, so that's these interest rates 148 00:07:45,510 --> 00:07:53,140 over here, the rule of 72 slightly over estimates how 149 00:07:53,140 --> 00:07:54,880 long it'll take to double your money. 150 00:07:54,880 --> 00:07:57,610 And as you get to higher interest rates, it slightly 151 00:07:57,610 --> 00:08:01,340 underestimates how long it'll take you to double your money. 152 00:08:01,340 --> 00:08:05,090 If you had to think about is 72 really the best number? 153 00:08:05,090 --> 00:08:06,840 Well this is kind of what I did. 154 00:08:06,840 --> 00:08:09,340 If you just take the interest rate and you multiply it by 155 00:08:09,340 --> 00:08:11,270 the actual doubling time. 156 00:08:11,270 --> 00:08:12,790 And here you get a bunch of numbers. 157 00:08:12,790 --> 00:08:14,940 For low interest rate 69 works good. 158 00:08:14,940 --> 00:08:17,360 For very high interest rates 78 works good. 159 00:08:17,360 --> 00:08:20,470 But if you look at this, 72 looks like a pretty good 160 00:08:20,470 --> 00:08:21,290 approximation. 161 00:08:21,290 --> 00:08:26,150 You can see it took us pretty well all the way from 4% all 162 00:08:26,150 --> 00:08:27,620 the way to 25%. 163 00:08:27,620 --> 00:08:30,310 Which is most of the interest rates most of us are going to 164 00:08:30,310 --> 00:08:32,409 deal with for most of our lives. 165 00:08:32,409 --> 00:08:34,299 So hopefully you found that useful. 166 00:08:34,299 --> 00:08:36,750 It's a very easy way to figure out how fast it's going to 167 00:08:36,750 --> 00:08:37,530 take you to double your money. 168 00:08:37,530 --> 00:08:39,015 Let's do one more, just for fun. 169 00:08:39,015 --> 00:08:44,680 170 00:08:44,680 --> 00:08:50,480 Let's say I have a 9% percent annual compounding. 171 00:08:50,480 --> 00:08:53,500 And how long does it take for me to double my money? 172 00:08:53,500 --> 00:08:59,610 Well 72 divided by 9 is equal to 8 years. 173 00:08:59,610 --> 00:09:02,810 It'll take me 8 years to double my money. 174 00:09:02,810 --> 00:09:06,200 And the actual answer-- this is the approximate answer 175 00:09:06,200 --> 00:09:12,190 using the rule of 72-- 9% is 8.04 years. 176 00:09:12,190 --> 00:09:15,940 So once again, in our head we were able to do a very good 177 00:09:15,940 --> 00:09:17,190 approximation. 178 00:09:17,190 --> 00:09:27,858