Advantages of using ‘The Rule of 72’
- Knowing how quickly or slowly your investments are growing.
- Better planning for future investments.
- Qualify your investments as ‘good’ and ‘not so good’.
Thumb Rule for Better Returns from Real Estate Investments
The fun in using a magic formula is seeing how it works. Let’s figure out how long it actually takes for money to double at a certain interest rate. Do you know the Rule of 72? Well, it’s an easy formula to calculate how long it would take for your money to double at a given interest rate. All you need to do is, take the number 72 and divide it by the interest rate you estimate your investment would grow by year on year. That figure gives you the approximate number of years it will take for your investment to double. You can also calculate the duration for the investment to triple by using ‘The rule of 116’. Here it goes…
Know and qualify your real estate investments better by applying these thumb rules.
In daily life, one would often come across people who have made great returns on their investments in Real Estate. They would talk of their investments made 10 – 20 years ago with fondness, as it is now worth a fortune.
Well, to tell you the truth, ‘I am impressed, but NOT yet’. Before I go on to explain myself, let me talk about a couple of thumb rules. The first rule is ‘The Rule of 72’. This rule essentially gives us the number of years ‘n’ required to double one’s money (by compounding) at a given interest rate’ r’, such that n = (72 / r). Hence by dividing 72 by an interest rate we can get the number of years required to double one’s money. Similarly by rearranging the formula one could find the interest rate required to double one’s money as r = (72 / n). The other rule is ‘The rule of 116’. This gives the duration required to triple one’s money as n = (116 / r).
These rules are good approximations and very useful for quick top of the mind calculations. A few days ago, I mentioned to my mother that a particular piece of land in a certain location was being quoted at close to Rs. 5 Cr. for a plot, and she asked with surprise, “wasn’t that land being quoted at Rs. 2.5 Crs. just recently?!” Well, that’s true, but ‘recently’, which was her last reference point was actually in 2006, and now 9 years later in 2015 the price of the plot is Rs. 5 Crs. and it does seem impressive. The huge quantum of Rs. 2.5 Crs. to begin with, had actually doubled.
However let us apply ‘The rule of 72’ and see. It has been nine years since 2006. An investor investing Rs. 2.5 Crs. has doubled his money. The interest rate required to achieve this by the ‘Rule of 72’ is r = (72 / n), substituting for n = 9 years (2006-2015) we have r = 8%. The investor’s investment really has grown by 8% compounded. Now if you consider the average inflation in India during this period 2006 – 2015, it has been about 8.76% (CPI-Consumer Price Inflation) (Source: Calculated from inflation.eu). So really the investor in real terms (i.e. adjusted for inflation) has actually lost money. What seemed like a brilliant investment on the face of it, is actually not so.
Now let us take a happier example. Consider this; Mr. Karthik who invested Rs. 25 lakhs in a property in the year 2001, during the start of the real estate boom. His investment in 2007 at the near end of the boom tripled in 6 years to Rs. 75 lakhs. Since his money tripled lets apply ‘The rule of 116’. Karthik’s return on investment was r = 116 / n (Note he tripled his investment so one has to use 116 in the numerator), where substituting for n = 6 years we have r is = 19.33% approximately. He got a return of 19.33% compounded over the 6 year period, when the real estate was in full bloom. For reference the average inflation (CPI) during this period
was 4.28% (Source: Calculated from inflation.eu). So he got a fantastic return on investment even in real terms.
One could simply apply ‘The rule of 72’ for calculations involving investments that have doubled and ‘The rule of 116’ for calculations involving investments which have tripled. These are thumb rule approximations which are very useful and come in handy. It helps one qualify one’s investments as ‘good’ and ‘not so good’ which could throw up surprising results. What may have once seemed like an excellent return on investment may either turn out to be a surprisingly poor one or may show surprisingly great positive results.
Apart from compounding playing a role, one also needs to be aware what one’s real return is. ‘Real return’ is when the return (i.e. nominal return) is adjusted for the average inflation (CPI) during the investment period. Hence nominal returns have always to be set against the backdrop of inflation to understand whether our investments have fallen behind or are ahead. High returns mean nothing if inflation is persistently high. Returns on investments are especially damaged during times of stagflation (times of stubborn inflation and stagnant growth). This is the reason why real estate as an investment has not done well during the period following 2007 until 2015. If one had invested before that period during the 2001-2007 real estate boom one would have particularly benefitted from high growth and moderate inflation. It is to be noted that when real estate investments stagnate it could often give negative real returns even though, on the face of it, it doesn’t seem so. This was particularly evident in our first example. Here even when the prices were seemingly rising and nominal returns were 8%, the investor was actually bleeding money.
So use these rules and know where you stand with respect to your investments. They can surprise you positively or negatively. So, how have your investments fared so far?
Image credit: www.stlfinancialcoach.com
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