This example dramatically illustrates the power of compounding because the growth rate is 100% per time period. But the principle works at lower growth rates; it just takes more time periods.The benefits of compound growth can be magnified with dividend growth compounding. As dividends increase over time the explosion of reinvested earnings is even more dramatic.
This makes time the most important aspect of reaping the benefits of exponential growth. This is why financial advisors exhort the advantages of starting your retirement plan early in life.
Double Time
Double Time is the number of time periods it takes exponential or compound growth to double a given amount. Time periods may be any measurement such as seconds, hours, days, months, or years. The amount measured could be anything that is growing at a constant rate such as the population, bacteria in a lab, or money.
Rule of 72
The Rule of 72 is a helpful concept to estimate double time. In order to approximate the number of years it takes to double an investment, divide the growth rate into 72. For example, if an amount is growing by 10% per period, it will take approximately 7.2 periods (73 divided by 10 = 7.2) to double.
Using Exponential Growth in Investment Planning
Double Time and the Rule of 72 are valuable tools in investment planning. If an investment is earning 8% per year it will take approximately 9 years to double (72 divided by 8 = 9 years). This means a $100,000 investment at age 20 would grow to $3.2 million without any additional capital. Forty-five years allows the $100,000 to double 5 times or every 9 years. This illustrates the power of exponential and compound growth as well as the importance of time.
Exponential growth is sometimes described as the “miracle of compounding” because of the extraordinary explosion that takes place over time. Investors can use double time and the Rule of 72 to estimate the power of exponential growth to meet their retirement goals. Use this important financial concept to meet your investment goals!
This article has been republished with Arbor Investment Planner.