How long will it take to double your Pension money?
I heard about the Rule of 72 recently in the context of pension saving. Can you explain what this is and why it’s important?
Mike Freer, business development manager, BWCI, replies:
IT may sound like the title of a lost episode of Dr Who, but the Rule of 72 refers to the power of compounding.
Compounding relates to the apparently disproportionate effect of reinvesting a little for a long time.
Pension schemes invest mostly in bonds and equities, both of which produce regular returns in the form of interest, dividends and capital growth. In pension schemes these amounts are not taken out, but are reinvested for the future; and they are invested for very long periods, typically decades.
Pension schemes also enjoy an extra benefit, because (subject to Income Tax limits) the tax that might otherwise be due is retained within the scheme for the benefit of the member.
The Rule of 72 is a ready reckoner. If you want to know how long it would take for your money to double in value as a result of compound interest, then all you need do is divide 72 by the interest rate it is likely to earn. Example: You expect to earn 6% pa on your pension plan investments, so you calculate 72/6 = 12 years. So even before any further contributions, you expect your account to be worth twice its current value in just 12 years. (The true answer is 11.9 years, so pretty close!)
You can run the calculation the other way round too. If you would be content to see a doubling in 16 years, what rate would you need to earn? Answer is 72/16 = 4.5% pa. (True answer 4.4% pa.)
So now that you can easily appreciate the power of compound interest on the future of your pension plan, you won’t be needing the Tardis.