The Law of 72!

[Dr. Scott Benjamin]

Folks,

I want to introduce you to an exiting financial rule that should get you all very excited.  When investing (whether it be stocks, bonds or real estate) your investment doubles based on 2 variables.  The first is time and the second is the interest rate.  Allow me to explain - if you had $10,000 to invest in the stock market and wanted to know how long it will take to become $20,000, you would take the interest rate (say 6%) and divide it into the CONSTANT 72 to see that your money would double in approximately 12 years.  Say you were more risky and tried to get 9% in the market, your money would double in 8 years (again, divide 9 by 72).  You can see the obvious relationship between interest rate and speed to double.

Now apply that to our real estate rental properties. If you own a house that is worth $100,000 - assume that the market appreciates at 6% (historically is about right) - that house becomes worth $200,000 in 12 years. That means, you made $100,000 in 12 years...pretty good. The difference between the stock market and real estate is incredible due to leverage. You would need $100,000 in cash to buy $100,000 in stock (we aren't going into margin accounts etc.) Now what is absolutely unbelievable, and separates real estate from the stock market, is that you probably bought that house with 25% down or just $25,000 for the same purchasing power. If you had $100,000, you could buy 4 houses for $400,000 and watch the power of compounding kick in. In another post, I'll discuss the ROI of stocks versus real estate. Really cool stuff! Happy Investing.

Scott Benjamin, PhD, MBA

The Absent Minded Professor

[Bill Gulley]

I suggest you divide 72 by 9 to get 8.

We also look at the relevance of risks of similar investments drilling a bit deeper into ROI, it's been discussed in the forums.

Since RE is unique, it is difficult to classify RE to other assets and since we have an active RE market we can generally have a sufficient population of comparative investments, which is why I don't compare RE to securities such as stocks or bonds. The liquidity isn't there for RE which pretty much makes RE a zebra without stripes.

The Law of 72 also assumes a constant and uniform compounding, market fluctuations in RE are seldom at an even pace of appreciation in the market. It can be more applicable to notes if they are performing and paid as agreed. The old "Rule of 72's" is older than I am but it certainly works.

BTW, the forums really aren't for a blog series, we have blogs on BP for such information. The podcasts are really something. The BP forums are for the Q&A discussions. Best of luck :)