Rule of 72

RULE OF 72

Everyone has heard someone mention the rule of 72 but it has been my experience not many understand what it means. The ones I have found who understand it the best are people involved in real estate. They realize that compounding your money is the name of the game and real estate is the best way to accomplish it.

Rule of 72 is a fast and easy way to calculate how long it takes an amount of money to double depending on the interest rate. Here is how it works. Divide the whole number of the interest rate or return into 72. The result is how long it takes for that amount to double in value. For example, if you wanted to find out how long it would take $10,000 to double if you could earn a 6% return. 72 + 6 = 12. This means it would take 12 years for the $10,000 to double at 6%.

Real estate investors figure their rate of return before buying a property and will usually want at least 18% return on their investment. This is not an unreasonable expectation. This type of return is common by investing in other instruments such as discount mortgages, tax certificates, creating notes in houses or becoming an equity lender. 72 + 18 = 4. At 18% it would take just four years for that money to double.

Think about what I just said. Instead of $20,000 at the end of 12 years like the person investing at 6%, your value over 12 years at 18% would make your money worth not $20,000 but $86,000! People who invest money in CD's today at 2%-3% will see their money double in just over twenty years. For the same time period, the person investing $10,000 at 18% would have realized over $320,000 after twenty years.

Leverage IS real estate and it gives high rates of compounding if you structure the deals properly. Only on a few occasions have I purchased a property that gave me less than a 30% return for the money invested. One deal I did was over 1000%, and on no money down/no settlement cost deals rate of return is infinite. If you can find a better way to compound your money with as little risk as real estate, call me. My bet is, I won't have any calls.

Don is author of Down to Earth Landlording and is a contributor to our "Tip-of-The-Week" segment.