This rule that will set you free.

I have seen so many people make this mistake trying to get debt free but for some reason they just can’t break away from debts grip.  With all the rules about getting out of debt spending less than you make is one that if not followed will never get you debt free.

For example I know people who make $200,000 a year but as a result of spending nearly more than they make they barely break even at the end of the month.  It’s always been said that it’s not how much you make it’s how much you save. 

Being in financial service you could say I’ve seen it all or close to it.  I’ve known people who’ve had 15 plus credit cards, car loans, HELOCS, and whatever else you can think.  I have even seen situation where people had so much debt that even if they made all of there payments they still couldn’t break even at the end of the month.  So in this article I decide to break things down a bit.

Einstein called this the 8th wonder of the world.

What I am referring to is the Rule of 72.  If you haven’t heard of it don’t worry most people haven’t.   The Rule of 72 work regardless of whether you know it or not.  It can work for you or against you.  Here’s how it works.

Take any interest rate you are earning and divide it into 72.  This will tell you how many years it will take for your money to double in size.

For example, let’s say you have $10,000 in an account earning 4% interest.  If you divide 72 into 4 you get 18.  This means it will take 18 years to double your money.     Which means your $10,000 would turn into $20,000.   Then 18 years after that you would double again to $40,000.  Sounds great but it takes 18 years to double your money.

So what would happen if we would get 6%?

72 divided into 6 is 12.  Which means it will take 12 years for your money to double.  So if you had $10,000 with a 6% interest rate it would double to $20,000 and 12 years after that it would double again to $40,000.  Getting better. 

Now here is what most people don’t realize.  Just by getting an extra 2% interest on your money you will double your money 6 years sooner than if you just got 4% on your money.

So what would happen if you got 8%?

It only gets better from here.  If you divide 72 into 8 you get 9.  Which mean again that your money would double in just 9 years.  Just by getting 8% and not 6% your money would double 3 years sooner and 8 years sooner if you only got 4%. 

Now let’s illustrate this.   We’ll do another example to help you understand this a little better. 

AGE                  4%                       6%                       8%

25                    10k                      10k                      10k

34                                                                            20k

37                                               20k

43                    20k                                                  40k

49                                               40k                       

52                                                                             80k

61                    40k                     80k                        160k

Look at this chart for a moment.  If at the age of 25 three people set back $10,000 and earn the three various interest rates 4%, 6%, and 8% what would they end up with if they all retired at 61?  The person who got 4% only made $40,000 after 36 years.  Then notice the person who got 6% got $80,000 after 36 years.  Just by getting 2% more.  And finally, the person who got 8% got $160,000 after 36 years.  That’s $80,000 more than the person who got 6%  and $120,000 more than the person who got 4%.

WOW!  What a difference a little interest can make. 

Sound great but this can also work against you as well.  Lets say you have credit card debt and you are currently getting charged 18% interest.  Well 72 divided into 18 is 4.  That means your debt is doubling every 4 years. 

The big mistake.

The problem is that if you are getting charged 18% interest on your credit cards and you only have your money invested at 4% is it no wonder that most Americans can’t get out of debt.  It’s like you’re playing a game of tug of war, but you just can’t win.

How Banks Make Money.

This is exactly how banks make money.  Take a look at the chart again.  If the bank was charging you 8% on all of your loans combined after 36 years with you paying in on your loans you would have gave the bank $160,000 in interest. 

Now, if you had $10,000 in the bank in a CD at say 4% after 36 years you would have $40,000 provided you added no more money to it. 

Its pretty simple how the bank made its money.  They took your $10,000 that you invested into the CD and turned it into $160,000.  Form there they paid you the $40,000 they owed you and the bank keeped the $120,000. 

Hardly seems fair, right?

So what should you do?

Two things you should do to get on the fast track.

1.  Start paying off your high interest rate cards first.  Not your mortgage or car loans. 

2.  Review where you invest your money.  Talk to a financial advisor about possible investments that would be suitable for you. 

Just by doing those two things you can easily put yourself in a position to be on the debt free fast track and beat the banks at there own game.