What the Rule of 72 tells us about our expectations for our investment portfolio
Compounding and the Rule of 72
If you are getting excited about investing in mortgage loans because of their simplicity and profitability, hold on to your hat, because it gets better.
Every month that you receive payments from borrowers, you have the opportunity to reinvest those funds. And when the homeowners pay off the loan early, those funds get reinvested, too, often back into a new loan. Thanks to the Rule of 72, you can figure out at what interest rate you need to reinvest those funds to double them during the timeline you choose.
The Rule of 72 is a mathematical formula that allows you to estimate the time it will take money to double at various investment rates. In general, you can expect money invested with a 1 percent return to double in seventy-two years. A 2 percent return doubles money in about thirty-six years. A 3 percent return doubles money in about twenty-four years, and so on.
If you earned 9 percent annually on your portfolio, it would take you eight years of compounding interest before your portfolio doubled in value. The formula for the Rule of 72 is:
((72/interest rate) = number of years to double)
The key for mortgage note investors who aren’t using their returns for current income is to continue reinvesting the earnings, keeping in mind that consistency over time beats a couple of great years over the long run.
Too often, I hear from people who keep their funds sitting in their IRA account because they’re waiting for an astronomical investment return. What these folks don’t understand is that, thanks to inflation, money not invested decreases in value each month, and accurate portfolio performance measurements must average in the amount of time investment funds went undeployed. This is the same dynamic involved in stock market volatility, which really damages returns over time.
I am a firm believer that returns are based on risk. Be very cautious of any offering that touts both double-digit returns and low risk. These types of offerings could end up costing you your entire investment.
Slow and steady growth wins the race. It’s much better to keep your money working for you consistently over time than it is to have it sitting on the sidelines decreasing in value, hoping that some “home run” investment comes along. Few of us would be shocked with a 9 percent return, but when you consider that it can double your money in eight years, it certainly sounds better than leaving those funds doing nothing in your IRA or risking their loss with that “sure thing” investment.