I recently had the opportunity to teach one class of my daughter’s 6th grade math class. Wesleyan School was kind enough to invite parents who wanted to bring “real world” math usage and share it with 6th graders. I chose the concept of the “Rule of 72.”
What is the Rule of 72?
Albert Einstein is rumored to have said that compound interest is the 8th wonder of the world. Whether or not this is true, or an urban legend, is a debatable point. But what is not debatable is the power of compounding interest. And this brings us to the Rule of 72. It’s a simple mathematical formula that provides us with a way to measure how quickly an initial investment may double, when measured against a hypothetical rate of return. For example, let’s say that an investor bought $5,000 worth of stock and received a 6% return. How long would it take the initial $5,000 investment to double in value, given a hypothetical 6% rate of return? Here’s the formula: 72 / 6 = 12. So, the answer, is that it would take 12 years for the investment to grow from $5,000 to $10,000, given the rate of 6% return.
Money Talks! Gaining the Attention of 6th Graders
For my daughter’s class, I knew if I wanted to gain the attention of a class of 12-year olds, I had to add a “wow” factor into my presentation. I started the class with one question: “Who wants to learn what it takes to get a million dollars?!” Of course, all the hands shot up. They seemed eager to learn or maybe they were just excited about the stacks of cash sitting at the front of the classroom.
You see, before I become a financial planner, I was first and foremost a teacher. I taught college music mostly, but I also taught middle school and high school students. Teaching is a passion of mine and I really wanted to share my passion for finance with my daughter’s class. During my preparation of my Rule of 72 lesson, I talked with my wife about what props I should use to gain the most impact. My wife, Ruthie, teaches middle school band at Wesleyan School. She was the one who had the great idea of using cash to teach the kids about how to become a millionaire. So, kudos to Ruthie. As they say, the apple doesn’t fall far from the tree. For those who know my father-in-law, James Calder (JC), Ruthie is JC’s daughter number 2 of 4.
My goal was to show how young investors might utilize the power of compound interest to save and build $1 million over their lifetime. Using the Rule of 72 and assuming a $5,000 investment for a 12-year old and a 12% rate of interest, the math is pretty easy to follow: 72 / 12 = 6. Therefore, it takes 6 years for an investment to double, given a 12% rate of return.
Rule of 72 Graphic. Assumptions: $5,000 initial investment at age 12 with a 12% rate of compounding returns. No withdrawals and tax-deferred growth
Now before I presented this graph to the class, I wanted to use some props to gain their attention. Otherwise, this chart is just a bunch of numbers. I knew that I wanted to use cash, so I thought about it for a while and realized that I could use a $5 bill to represent $5,000. At that ratio, I would need $1,280 worth of $5 bills. I made a trip over to the bank, shared my lesson plan with them, and they were very kind to be a part of it, and I made the withdrawal of $1,280 worth of $5 bills. With prior approval of the math teacher, I brought the cash to the classroom.
Before class, I grouped the $5 bills together using paperclips into the following stacks: $5, $10, $20, $40, $80, $160, $320, $640. That way, as I stacked them up, it would total $1,280, which was my equivalent to $1,280,000.
It was so much fun! During the presentation, each time I stacked the next group of $5 bills on top of each other, I prompted the class to call out, in unison, the answer based on the chart above. It was so much fun to see a room full of 12-year old children light up. I’m sure that the stacks of $5 bills brought out most of the excitement, but the props helped drive home the lesson. I explained to the class that for most folks, wealth is accumulated. It’s not inherited. And many folks, who earned a modest salary during their lives, figured out how to become a millionaire. They lived within their means, stayed clear of bad debt, and saved for the future. That brings me to the point of this lesson for us to consider.
Form this lesson, I have an important question for all of us to consider: Are you and I smarter than a 6th grader? Do we take advantage of compounding interest or do we let it take advantage of us? Think about it like this: Borrowing from Star Wars references, the Rule of 72 has a “Light Side of the Force” and a “Dark Side of the Force.” The Dark Side is deceptive and seductive. And the powers of the dark side can lead you to taking on bad debts, such as credit card and car loans, and possibly unaffordable mortgage and student loan payments. In these instances, the Dark Side of the Rule of 72 will work against you – quite POWERFULLY! Have you ever heard the phrase, “I can’t seem to get ahead?” This is the mark of the dark side of the Rule of 72. But if we live with good financial margin in our financial lives and we are able to save and invest for retirement, then the “light side” of the Rule of 72 becomes your friend.
Consider using a Rule of 72 scenario for yourself. And if you have children or grandchildren, take a moment to explain this vitally important concept to them. There are many positive aspects to wealth building through the Rule of 72. It may lead to financially healthy lives, financially health marriages, and financially healthy retirements. And the wealth that is built may also be used by the next generation of big-hearted givers, who use their financial resources to make an impact not only for their families but for their communities and the needy as well.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.