Inflation And The Rule of 72
In the world of investing, there is a well-known concept referred to as the Rule of 72. It states that because of compound interest, 72 divided by your rate of return will always yield the number of years necessary to double your initial investment. The simplest math to do it with would be that it takes 10 years to double your investment at a 7.2% interest rate (72 / 7.2 = 10). However, below is an excel sheet drawing out the rule with rates of one through ten percent.
Because inflation detracts from your return, the most accurate way to find how often the real value of your investment doubles is to actually measure 72 divided by the rate of return minus the inflation rate. Forty years ago, to achieve a fairly large real rate was fairly feasible even in the face of what was considered fairly high inflation. In 1982, exactly forty years ago, the average CD was a little over 14%. So even though inflation was over 6%, all it took to earn an 8% real return was a simple short-term CD. At that difference of about 8%, it would only take 9 years to double your money!
Times have changed. Inflation today is right about 8.6%. However, artificial interest rates being held low by the federal reserve has led to the average CD rate sitting below one percent. As a result, the real return is between negative seven and eight percent! This means that it would take between nine and ten years, not for your money to double, but rather it would take less than a decade for your investment to be cut in half!
Even this is only telling part of the story. This is because between 1982 and today, we’ve also changed the way in which inflation was measured. By the old metric, inflation would actually be sitting at about seventeen percent. Plugging that into the Rule of 72 would give us 72 / (0.73 – 17), which tells us that it will take under five years for your investment to be cut in half!
Realistically speaking, it’d be all but impossible to maintain this 8.6% (or 17% by the old metric) inflation for ten years or even five years. Such prolonged inflation would either have to snap into a recession or snowball into hyperinflation as Americans gave up all faith in the dollar. However, it is an important lesson in just how impactful inflation really is. It’s not always the most exciting, front-page topic, but inflation is so much worse than the brutal gas and home prices we are dealing with – though those are already crippling. It is on a high speed track to crippling and most literally halving the real return of your savings.
No matter what we’re facing, inflation like this is never worth it. As Ludwig von Mises has said:
No emergency can justify a return to inflation. Inflation can provide neither the weapons a nation needs to defend its independence nor the capital goods required for any project. It does not cure unsatisfactory conditions. It merely helps the rulers whose policies brought about the catastrophe to exculpate themselves.
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This article was published by the Ludwig von Mises Institute and is reproduced with permission.
