Investing vs. Speculating and the Rule of 72

Within the last 5 years this county has experienced one of the biggest booms in market history and somehow managed to experience one of the biggest market bust. During this same time, the number of millionaires in this country has skyrocketed while the number of people living in poverty increased at the same rate.

With such a dichotomy between success and failure over the same time period, how does an individual plan their financial future? On the one hand we have investors who made millions of dollars investing in the market, and on the other hand we have millions of speculators who did the opposite.

Fortunately, we all have the potential to be in the former group; unfortunately many of us do not understand the sacrifices and knowledge it takes to attain this type of success.  This is why I would like to present you with two concepts that lay a solid foundation of investment principles that will lead you in the direction of above average returns on your money.

Investing vs. Speculating

Some of you may have noticed two important terms I used as I started this essay: investors and speculators.

Understanding the difference between this two little words may be the most important concept to learn for a solid financial foundation. So what is the difference between an investor and speculator?

An investor is someone who proactively researches the intrinsic value of a company, property, or business venture. Then, he or she will never put any money into the venture unless they can get in at a substantial discount to this intrinsic value. On the other hand, a speculator does not do his due diligence. Rather, a speculator puts money into a venture based on emotion, chance, or a blind tip.

For example, if someone wants to open a night club because they think it will be fun and feels like it will make money because they see a bunch of other clubs making money, or someone decides to buy a stock because they heard it was going to blow up, or someone buys some rental property because they heard real estate is where its at, they are speculating.

On the other hand, if someone researches a target market, finds a substantial demand for a product, buys a stock below its actual worth or purchases real estate because they can get it at a discount price, this person is investing.

It is imperative that before you put any money into a venture, whether it’s a stock, bond, real estate, starting a business, or investing in someone else’s business, that you ask yourself if your are investing in this venture or speculating in it. Remember, investors always win and speculators are gamblers; don’t gamble with your future.

The Rule of 72

The next concept necessary to know for a solid financial foundation is the Rule of 72.

This concept is very basic and easy to commit to memory. The Rule of 72 shows how long it takes to double your money at various fixed annual rates of return. The formula is: 72 divided by your rate of return equals the number of years to double your original investment (72 / rate = years).

For example, if you were to invest in a Certificate of Deposit (CD), that had a 4% annual rate of return (72 / 4), it would take 18 years to double your money. Therefore, if you invested $10,000.00 into this CD, your money would grow to $20,0000.00 in 18 years. All calculations for the Rule of 72 assume the earning from interest are reinvested to provide compounding of the interest or dividends.

Obviously, the higher rate you get the faster you can double your money. But sometimes it is hard to fathom how much the difference in rates can affect your long-term investment results.

For example, lets look at the difference between earning 8% and 12%. Earning 8% it will take nine years to double your money, while earning 12% it will take only six years. Now look how this affects your return over time with the initial investment of $50,000.00.

Earning 8%:
Age 35 – $50,000.00
Age 44 – $100,000.00
Age 53 – $200,000.00
Age 62 – $400,000.00

Earning 12%:
Age 35 – $50,000.00
Age 41 – $100,000.00
Age 47 – $200,000.00
Age 53 – $400,000.00
Age 59 – $800,000.00

So what we see here is that investor 1 got an 8% return and earned $350,000.00 over 27 years, while investor 2 got only a 4% higher return but earned $750,000.00 over 24 years. WOW!!! The bottom line is that improving your return on investment can substantially impact the long-term value of your investment portfolio.

Basic Stuff, but Powerful

These two concepts may seem basic in nature, but can make a world of difference when applied to your everyday investment strategies. It comes down to these two things; always, and I mean always do your research, and a great interest rate is worth accepting a little more risk.