Disclaimer: I found this article on MSN Money website and you can read more of the author - Liz Pulliam Weston articles under Personal Finance section. The inflation she talks about in the article is for USA base on the historical data. I hope you will enjoy it.
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None of these tricks requires more than simple arithmetic (addition, subtraction, division and multiplication), and some of them you can do in your head. Some are so simple they can be explained in a few sentences; if it takes longer and you're in a hurry, you can read the last paragraph of each section to get the rule of thumb.
The rule of 72
Need a quick way to estimate how long it will take for your money to double at a given rate of return?
Divide the return into 72. So if you're averaging an 8% annual return, it will take you nine years to double your money (72 divided by 8 equals 9).
The rule of 70
Inflation erodes the buying power of a dollar, so that eventually it will buy only half of what it used to.
Want to know how quickly your money will lose half its buying power? Divide 70 by the expected inflation rate. If it's 3.5%, your dollar will be worth 50 cents in 20 years (70 divided by 3.5 equals 20). If inflation soars to 10%, your money's value is halved in seven years.
Understand the value of compounding
It's been called the Eighth Wonder of the World, but many people still don't grasp how amazingly investment returns can add up over time.
One way to dramatically illustrate the point is to use the example of the doubling penny. If I give you a penny at the start of the month and promise to double it every day, you'll have $10.7 million after 30 days.
Of course, you're not going to double your money every day or even every year. But 8% or 9% is a reasonable rate of return to expect over the long run on a diversified portfolio of stocks, bonds and cash, so doubling your money every eight or nine years (remember the rule of 72) is well within the range of possibility.
The following chart demonstrates how quickly a $100 investment can grow given different interest rates and time periods.
How $100 can grow | |||
After: | 6% | 8% | 10% |
10 years | $179 | $216 | $259 |
20 years | $320 | $466 | $673 |
30 years | $574 | $1,006 | $1,745 |
40 years | $1,028 | $2,172 | $4,525 |
This chart can be used the other way around to illustrate future gains you lose when you aren't invested. If you withdraw $100 from a retirement account at age 25, for example, you're giving up more than $2,000 of future retirement money, assuming 8% average annual returns over the next 40 years.
Here's a way to further boil it down: Every dollar you invest can grow to $2 in 10 years, $5 in 20 years, $10 in 30 years and $20 in 40 years, assuming an 8% average annual return.
Calculating 'Take this job . . .' money
How much money would you have to save, inherit or win to say goodbye to work?
You'll find plenty of retirement planners around the Web, including MSN Money's Retirement Planner, which I find particularly easy to use. Personal-finance software like Money and Quicken includes more sophisticated calculators that are also worth a look.
But if you want to ballpark a figure for what you'd need to save to stop work tomorrow, simply multiply your living expenses by 25.
Why 25? Because financial planners generally agree that 4% is a "sustainable" withdrawal rate from a diversified portfolio of stocks, bonds and cash. That means you can take out 4% of the total in the first year, adjust the withdrawal every year afterward by the inflation rate, and face relatively little risk of running out of money.
So to get the lump sum you'd need, you divide your annual living expenses by 0.04 -- which is the same as multiplying the same expenses by 25. If you need $30,000 to live on, you'd need $750,000. If you want to be more conservative and reduce the chances of running dry to virtually zero, multiply by 33 instead. That approximates an initial withdrawal rate of slightly more than 3%.
Columns by Liz Pulliam Weston, the Web's most-read personal finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.