In this article, we’re going to talk about “How to Use the Investment Calculator.” What you’ll learn is why compound interest is KEY to determining your future wealth and how to use the investment calculator and how to estimate compounding without the calculator using the Rule of 72.
The reason I want to talk about the investment calculator is that I’ve gotten several questions about how to actually use the Money Chimp calculator that I keep referencing. I’ve told you about the power of compounding and hope you really understand it. Compound interest is key to determining your future wealth.
One billionaire insists each of his investments must earn 10% annually. This doesn’t seem like an overly high goal, but you can see how his laser-focus is on compounding. Billionaires know how important compounding is and how it is the key to wealth.
There are 2 different ways to calculate compounding. There’s the future value of a lump sum and the future value of an annuity stream. For example, a lump sum obviously would be a one-time payment and calculating the future value of that would tell you how much that will grow to in the future.
The future value of an annuity stream would be like if you were paying in money to your 401K, and you’re making an investment on a regular basis. How much would that grow to over time? Obviously with the lump sum you’re only compounding once per year and with the annuity stream you’re compounding it every time you put money in, so it’s going to grow a lot faster with the annuity stream.
Moneychimp.com is a free site that calculates future value. I love using Moneychimp because I can calculate. I don’t need a fancy calculator and don’t need to know how to do any programming on a calculator. I used to have a HP calculator and know how to do all that stuff and now it is just simpler. So, I go to Moneychimp.com and it’s just really easy.
When you go to Moneychimp.com there is a black bar at the top. Click on the word “Calculate” in the black bar. A little box will open up. It will ask you “What’s your current principal?” which is what amount are you wanting to invest? It will also ask for annual additions. You’ll use that only if you are adding money to the original amount like I mentioned in the 401K. If you have a stream of money that you are investing then you can see how additions will make you wealthier a lot faster. Most of the time we are going to be using a lump sum. You can leave the other part blank.
“Years to grow” is how long are you going to be growing the money? The longer you grow it, the more dramatic because with compounding it starts to go parabolic. So you want to have the longest period possible that you can compound it. Then it asks what interest rate, so that’s what you’re going to earn on your money. And it’s so fun to play with the interest rate number because you can see what would happen if you made 10%, what happen if you made 12%, that’s 20% more but it can often make a bigger difference in compounding over time, of course.
There’s also a place where it says “Compound Interest” and has a blank time annually. So, you can put in a number there, how many times annually you want to compound. Most of the time we are going to use one. So, compound interest one-time annually. Then it asks if you want to make an addition at the start or the end of each compounding period. Again, most investments compound at the end of the year so we use at the end of each period. Then you just click on the “Calculate” button and up come the future value, which is really fun and easy to calculate.
Go back and play with time and with interest rates and you’ll see how time impacts your investment and how interest rates impact your investment. If you don’t have a lot of time (years) to compound, you can make up for that with a higher interest rate. You can see how lower interest extends the time that you need to invest. Play with time and play with interest rate and see how those really impact compounding.
The more comfortable you get with this, the more it is going to help your wealth building and it really is such an important principle to get to know. Don’t skip this because like that billionaire who knows that 10% per year is his number that he has to reach in order to continue to build his wealth, and his laser focus is on that, you want to know about compounding. You want to know what this is going to do ultimately to your wealth and where you are going to end up.
You can also calculate the future value of money without using this calculator and you can do it by estimating what your compound interest number is going to grow to in the future using the “Rule of 72.” You may have heard the “Rule of 72” before and I hope you already know how to calculate it, but if you don’t I’m going to show you how.
Money doubles when interest rate times compounding time equals 72. Again, money doubles when the interest rates times the time you have to compound equals the number 72. So, for example, your money will double at 8% in nine years because 8 times 9 is 72. Or at 9% in 8 years because 8 x 9 is 72. If you could earn 8% for 9 years your money will double. Same thing, 6% at 12 years or 12% for 6 years equals 72. Or 10% for 7.2 years.
Let me give you some examples to clarify a little bit more. Let’s say, I read in the paper that housing values have doubled in 9 years. If we know that they’ve doubled, it must equal 72. It’s a DOUBLE and we have two of the numbers which is 9 years and it will equal 72. So what times 9 is equal to 72? Eight (8), so it would be 8% per year was the compounding rate for your house to double in 9 years. See how that works?
Now let’s say, you’re talking with a friend and you say to them “I hope to double my money in 6 years!” What interest rate would you need to earn if you were to double your money in 6 years? Well, we know it has to equal 72 and we know it is 6 years, so 6 times some interest rate equals 72. It’s 6 times 12. You have to earn 12% for 6 years in order to double your money. See how it easy that was?
Now, how about the other way? How about if someone said, “I’m going to earn 6% in this investment for the next 12 years and it is guaranteed for 12 years.” How much will your money grow to? Well you know that 6 times 12 equals 72. So, you know that your money is going to double because 6% times 12 years equals 72.
Also, if you wanted get start today to take a positive action step for your wealth then sign-up for my free course, “21 Days to a Wealthy Mindset.” This is a course I put together that teaches you all about how to think bigger, remove your limiting beliefs and get yourself more geared toward wealth. This is something that everybody needs to do. That’s all for today until next time – live the good life and be wealthy and smart!