Wednesday, December 30, 2009

The 8th Wonder of the World.

Albert Einstein told us that the eighth Wonder of the World was compounding interest. Compounding interest is either your very best friend if you are earning it, or your very worst enemy if you're paying it. If you have ever tried paying off a credit card with minimum payments you know of what I am speaking. This is the same if it is you personally paying or earning interest, if a company is, or if the government is. With our out of control government spending the interest is going to be frightening indeed.

The Rule of 72:

To be able to do compound interest problems in your head, the Rule of 72 gives you a lightning fast benchmark to determine how good (or not so good) a potential investment is likely to be.

The rule of 72 says that in order to find the number of years required to double your money at a given interest rate, you can just divide the interest rate into 72.

For example, if you want to know how long it will take to double your money at eight percent interest, divide 8 into 72 and get 9 years.

The rule of 72 is remarkably accurate, as long as the interest rate is less than twenty percent.

You can also run it backwards. If you want to double your money in six years, just divide 6 into 72 to find that it will require an interest rate of about 12 percent.

If you really want to see magic look at the below example.

If I were to offer you a special project for next month, and would either pay you 100,000.00 dollars for it, or give you a penny on day one and double it everyday which would you take?

1. .01
2. .02
3. .04
4. .08
5. .16
6. .32
7. .64
At the end of your first week you would earn 1.27.

8. 1.28
9. 2.56
10. 5.12
11. 10.24
12. 20.48
13. 40.96
14. 81.92
At the end of two weeks you would have earned 543.00.

15. 163.84
16. 327.68
17. 655.36
18. 1,310.72
19. 2,621.44
20. 5,242.88
21. 10,485.76
At the end of three weeks you would have earned 21,352.11.

22. 20,971.52
23. 41,943.04
24. 83,886.08
25. 167,772.16
26. 335,544.32
27. 671,066.64
28. 1,342,177.28
29. 2,684,354.56
30. 5,368,709.12
31. 10,737,418.24

At the end of the month you would have earned 21,475,192.00.

Hope this math is enlightening to you. Keep it in mind when you hear that we are going to borrow billions here, and trillions there.

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