The Rule of 72 and ETFs vs. Mutual Funds

If you want to know how many years it’ll take you to double your money, use the rule of 72.

Divide 72 by x% and you’ll have the number of years it’ll take you to double your money.

Say you have $1000. If you earn 6% annually on it, it’ll take you 72/6 = 12 years to double your money to $2000.

Now say you earn 8% annually on your money. It’ll take you 72/8 = 9 years to double your money to $2000.

So if you earn 8.5% annually on your mutual funds, but your manager takes 2.5% you actually get 6% net return. But, if you invest in ETFs (Exchange Traded Funds) and get the same 8.5% return with only a 0.5% management fee you get an 8% net return. Does that 2% really make that much of a difference?

Let’s take that same $1000 and invest it over 36 years. With the mutual fund at a net 6% return you’ll double your money three times for a grand total of $8000.

With an ETF at a net 8% return you double your money four times in 36 years for a grand total of $16,000.

Now, let’s say instead of investing $1000, you invested $50,000, and nothing else, from age 25 to 61 (36 years) at 8%. You would have a grand total of $800,000 at retirement instead of a mere $400,000 at 6%. Now do you see why 2% matters?

Of course, if you factor in 2% inflation* over those 36 years (36x2=72) you’ll see the cost of living doubles. So your future $800,000 will only have $400,000 purchasing power in today’s dollars.

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*Inflation in Canada has been at 2% annually since the 1990s. It was a lot higher in the 1970s and 1980s. http://www.bankofcanada.ca/rates/related/inflation-calculator/

DEFINITION of 'Rule Of 72'

A rule stating that in order to find the number of years required to double your money at a given interest rate, you divide the compound return into 72. The result is the approximate number of years that it will take for your investment to double.

DEFINITION of 'Exchange-Traded Fund (ETF)'

An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.

DEFINITION of 'Mutual Fund'

An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

DEFINITION of 'Index Fund'

A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.

Investing in an index fund is a form of passive investing. The primary advantage to such a strategy is the lower management expense ratio on an index fund. Also, a majority of mutual funds fail to beat broad indexes, such as the S&P 500.