Can The Rule of 72; Impact Your Retirement?

YES, IT CAN! Before we take the required steps to address the Rule of 72’s impact on your retirement; let us take one step back and explain the mysterious mathematical formula.

The Rule of 72 is a mathematical formula, which, allows you to calculate the timeline for your capital to double; at various interest rates...

Therefore; any interest rate, divided into 72, will give you the required years for your capital to double. As an example, if I invested $10,000 @ a 6% rate of return it will take 12 years to double; therefore, $10,000 invested at 6% will grow to $20,000 in 12 years.

The Rule of 72 has a direct correlation to your retirement, for starters, if you are betting on the wrong horse (your investment portfolio) your expectations versus your reality will be vastly different.

As an example, let’s say you started a monthly RRSP contribution plan with a blended portfolio mix that doesn’t correlate to your risk tolerance; your retirement funding may realize a shortfall; especially, if you were not aggressive (early on...).

Let us expand further; at age 35, most Canadians have a 30-year investment timeline to their prescribed retirement age of 65; however, when the portfolio was constructed, it projected a compounding rate of 8% annually; at an 8% annual rate of return, you can predict what your retirement nest-egg would look like. (If you are not sure how to calculate your numbers; reach out to us, we will help you).

However, if your risk tolerance changed and those changes were not reflected in your investment mix, your long-term projected nest egg may not be sufficient to sustain your retirement*. I will dive into an actual example, later in this article, which will further explain the significance of the Rule of 72.

* At this point, I would like to add a few key points on timelines. Canadians cannot project their mortality; thankfully, we are living longer and healthier and instead of your retirement horizon lasting 10-15 years, it's now closer to 15-20 or more...

When you create your long-term retirement plan; make sure your future income (indexed of course) will provide you with income for 15-20 plus years after turning 65.

The Rule of 72 also applies to inflation; at a 2% inflation rate; the cost of goods and services will double in 36 years (72/2% = 36 years). Why is this important, when you are creating your portfolio, you must factor in a minimum inflation rate of 2%; some advisors may even go higher and peg inflation at 3%?

The primary advantages of factoring in a 2% or 3% inflation rate, would be; a) to ensure your portfolio outperformed the rate of inflation and; b) your future account values would have been indexed for inflation.

Based on 2021’s low-interest environment, we are projecting a conservative 5% annual rate of return; however, when you add an inflation rate of 2%; your new targeted rate of return should be 7%. Therefore, if you are staying put with a 7% rate of return; you now know your capital will double in 10.28 years (72/7% = 10.28 years).

The last thing you would ever want in your investment portfolio is to build it on hope or winning the lottery. Yes, at times, some sectors beat the market, which produces a temporary higher annual rate of return, however, my advice; that’s the gravy, do not focus on these bumps.

Bonus: if in the next 12 months, your portfolio generated a 12% rate of return due to a couple of stocks within your investment mix taking off; say thank you, and quickly revert to your 7% target. Never; re-calibrate your projected retirement numbers after a banner year!

For those of you who are old enough to remember the 1998 technology runup (before its severe correction), everyone and their mother were making money if they were invested in the technology sector. Fortunately, I lived thru that era, and I saw clients who took my advice and clients who didn’t take my advice, allowed their greed factor to set in and suffered for it.

WORD OF CAUTION: Do not chase last year's returns and expect the same in the current year. I would run out of fingers and toes of clients who insisted on going against our recommendation and greedily dumped more money into a bullish sector. I can also point out clients who followed our advice, took their profits from their surging portfolio, and redirected that capital (profit) into a calmer, steadier blend of balanced and income funds.😊

As we conclude this week’s article; the lesson here is to pay attention to your portfolio's projected rate of return and continuously monitor the impact the Rule of 72 will have on your journey. Staying too long into a low-interest fund or not getting out when advised can work against you.

So, the next time you discuss a rate of return; quickly do the math and calculate the number of years in which your capital would double; have some fun with it, but be aware, make sure your risk tolerance is reflected in the blend of your investment mix; in order to satisfy your Rule of 72 calculation.

Exercise: Do you love math? Have some fun with the 3 questions; fire off the answers when you're done...

Projected Retirement Nest Egg...$1,200,000

Rate of Return...(Q1) 6% - (Q2) 7%

Inflation Rate...2%

Timeline...30 Years

1st Exercise: How much money would you have to invest monthly, to achieve your projected retirement nest egg of $1,200,000 at a 6% rate of return?

2nd Question: How much money would you have to invest monthly to achieve your projected retirement nest egg of $1,200,000 at a 7% rate of return?

3rd Question: At age 65; how long will your money last; if you withdrew 10% annually for living expenses? (Trick Question; I left out a factor; figure it out...)😊

Guys/Gals; if you find these little hints and quizzes fun; let us know and we will include them in all future articles.