Transcript Rule of 72 - Mr. Hudnall

Rule of 72 and
Rate of Return
Financial Literacy
Rule of 72
Allows a person to easily calculate when the future value of an
investment will double the principal amount
72
Interest
Rate
Number of years
needed to double
the principal
investment
Albert Einstein
“It is the greatest
mathematical discovery of
all time.”
Credited for discovering
the mathematical
equation for compounding
interest, thus the “Rule of
72.” At 10% interest rate,
money doubles every 7.2
years,
T=P(I+I/N)YN
What Can the “Rule of 72” Determine?
How many years it
will take an
investment to
double at a given
interest rate
How long it will
take debt to
double if no
payments are
made
The interest rate an
investment must
earn to double
within a specific
time period
How many times
money (or debt)
will double in a
specific time
period
“Rule of 72” FYI
• Only an approximation
• Interest rate must remain constant
• Interest rate is not converted to a
decimal
• Equation does not allow for additional
payments to be made to the original
amount
• Interest earned is reinvested
• Tax deductions are not included
Doug’s Certificate of Deposit
Doug invested $2,500 into a Certificate of
Deposit earning a 6.5% interest rate. How long
will it take Doug’s investment to double?
• Invested $2,500
• Interest Rate is 6.5%
72
6.5
11 years
to double
Jessica’s Credit Card Debt
Jessica has a $2,200 balance on her credit card with an
18% interest rate. If Jessica chooses to not make any
payments and does not receive late charges, how long
will it take for her balance to double?
• $2,200 balance on credit card
• 18% interest rate
72
18
4 years to
double
Jacob’s Car
Jacob currently has $5,000 to invest in a car after
graduation in 4 years. What interest rate is required
for him to double his investment?
• $5,000 to invest
• Wants investment to double in 4 years
72
4
years
18%
interest rate
Rhonda’s Treasury Note
Rhonda is 22 years old and would like to invest
$2,500 into a U.S. Treasury Note earning 7.5%
interest. How many times will Rhonda’s investment
double before she withdraws it at age 70?
72
7.5%
= 9.6 years
to double
investment
Age
22
Investment
$2,500
31.6 (double once)
41.2 (double twice)
50.8 (double 3 times)
$5,000
$10,000
$20,000
60.4 (double 4 times)
70 (double 5 times)
$40,000
$80,000
Another Example
$500 invested at age 18
7% interest
How many times will investment double before
age 69?
72
7%
= 10.2 years
to double
investment
Age
18
Investment
$500
28.2 (double once)
38.4 (double twice)
48.6 (double 3 times)
$1,000
$2,000
$4,000
58.8 (double 4 times)
69 (double 5 times)
$8,000
$16,000
Rate of Return
Total return on investment is expressed as a
percentage of the amount of money invested
Remember:
Return is the
profit or
income
generated by
savings and
investing
Total
Return
Amount
of
Money
Invested
Rate of
Return
Investments usually earn higher
rates of return than savings tools
What is Mandy’s Rate of Return?
Mandy saved $2,200 in a money market deposit account. After one
year, she has a return of $110. What is Mandy’s rate of return?
$110
$2,200
.05 =
5%
Mandy’s rate of return on investment is 5%
What is Derek’s Rate of Return?
Derek invested $900. When he withdrew his money from the
investment, he had a total of $1,050. What is Derek’s rate of return?
$150
$900
.167 =
16.7%
Derek’s rate of return on investment is 16.7%
Return on Stocks
Dividends
Market Price
Definition
Share of profits
distributed in cash
to stockholders
Current price that a buyer
is willing to pay for stock
What is
received?
Stockholder may
or may not
receive dividendsdepends on
company profit
If stock is sold for
a market price
higher than what
was paid
If stock is sold for
a market price
lower than what
was paid
Stockholder will
receive a return
Stockholder will
lose money
Return on Stock
 When an investor receives a dividend, it will increase
the return on the stock
 Example: Kevin buys stock worth $1,000.
Every year he gets a dividend of $50
After five years, he sells the stock for $1,500
What is his rate of return?
Dividends:
Increase in Value:
$50 X 5 years =
$1,500 - $1,000 =
$250
$500
Return on
Investment:
$250 + $500 =
$750
Rate of Return:
$750/$1,000 =
.75 or 75%