Rule of 72

The Rule of 72 is a simple calculation that can be used to estimate the amount of time it will take for an investment to double, no calculator necessary! Well I concede, maybe a basic one…unless you can divide numbers like 3.4 into 72 in your head, in which case, props to you…but most probably can’t, so grab a simple four function calculator and you will be completing compound interest problems in no time!

Example:

I am going to invest \$1,000 in a money market account with a yearly interest rate of 2%. To estimate how long it would take my \$1,000 to become \$2,000 I would divide 72 by the interest rate of 2 (72 / 2). The answer, 36, is about how many years it would take for my initial investment of \$1,000 to double. The actual amount of time it would take is 35.003 years, as you can see; using this rule we can get fairly accurate answer with no complicated math!

Bonus uses for the rule of 72

There are two other ways this rule can be utilized. First we can use it to see the effect of inflation on our purchasing power and second, to determine the interest rate required to double an investment in a certain amount of years.

The inflation rate is 4% and Jill has \$5,000 in her emergency savings fund which earns no interest. She is concerned about the inflation rate and wants to estimate how long it will take for her savings to lose half its value due to inflation. Using the rule of 72 she divides 72 by the inflation rate, 4 (72 / 4) to estimate 18 years. If the inflation rate remains constant Jill can assume in roughly 18 years the buying power of her savings account will be halved. Meaning if she can buy 5,000 iTunes songs today for \$5,000 she can expect the same \$5,000 in 18 years to only purchase 2,500 iTunes songs.

Interest Rate Required Example:

Bill is ambitious and wants to double his money in 10 years, to figure out an approximate interest rate he would need to invest at he divides 72 by the number of years, 10 (72 / 10) to obtain 7.2. In order for Bill to double his money he will need to find an investment vehicle which yields 7.2% annually for 10 years if he is to achieve his goal.

What is – A Federal Withholding Allowance?

A Federal withholding allowance is the governments way of allowing you to adjust your taxable income, the basis for the federal tax withholding seen on your paycheck. Allowances are claimed on IRS Form W4, (it is one of the forms you must fill out when starting a new job). Some examples of federal allowances are:

• Dependents you claim on your tax return (ie children)
• If no one else can claim you as a dependent on their tax return
• If you plan to file as head of household on your tax return

In the tax year 2011 each federal allowance claimed reduces your taxable income by \$3,700.

Example:

Mark is a single male with no children and has a gross income of \$50,000/year; he has no pre-tax deductions, making his taxable income also \$50,000/year. A few months later Mark gets a new job and needs to fill out his W4, he realizes he was claiming no allowances before, (being just out of college when he filled out his first W4 he didn’t quite know what he was doing) and adjusts to claim 1 (no one else can claim him as a dependent on their tax return). This lowers Mark’s taxable income by \$3,700 to \$46,300, which also reduces his monthly federal tax withholding, boosting his monthly net income or take home pay.

An important note

You can claim as many allowances as you want on your W4, but this does not change the amount of federal tax owed in a given year. Claiming an allowance only lowers federal income tax withholding, come tax return time if you claimed ten allowances but only two actually apply (the government will check, so will any tax prep software) you will be stuck with a big fat tax bill, owing big Sam all that money which wasn’t withheld from your paycheck. On the contrary, if you receive a large refund you may want to consider increasing the number of allowances claimed, instead of waiting an entire year for that money you will receive a small piece of it every month because of reduced tax withholding.

What is – Taxable Income?

Taxable Income – The monetary base from which you are imposed a tax. Taxable income for the federal government is usually any income received over the course of the year (gross income) less deductions (such as a federal allowance or 401k contribution) and expenses as deemed allowable by the IRS. Taxable income at the state level is determined by the state’s taxing authority and can differ from the federal government and from state to state.

Simple example: John has a gross income of \$50,000/year he contributes \$5,000/year to his 401(k) retirement account and has claimed one federal allowance on his W4. In this case John’s taxable income would be \$41,300.

Gross Income: \$50,000

Less 401(k): \$5,000

Less Allowance: \$3,700

Taxable Income: \$41,300 (this is the number you would use when referencing the IRS withholding tables to determine withholding)

Bottom line, taxable income is the number used to calculate the taxes you owe, whether it is to the federal, state, or local government.

Odds and Ends

So I have decided to add an “Odds & Ends” section to my blog for the purpose of sharing interesting non finance related things I find online and random thoughts of mine. Yes, most posts will be related to personal finance, but I figure why not share other interesting tidbits while I’m at it and have the platform to do so.

Being Frugal Makes You a Loser

Check out this blog post I found while surfing twitter the other week:

http://www.ajkesslerblog.com/being-frugal-makes-you-a-loser/

The essential argument is don’t cheap out and get something of lower quality just to save a few bucks, in the long run spending the extra \$\$ will save you a lot of heart ache and stress. I can personally relate because of how frugal I can be at times, very often I am tempted to save that extra \$10 only to be disappointed with my purchase down the road.

Welcome!

Welcome to “I’m Bad at Spending Money” a personal finance blog aimed at providing the basic knowledge and tools needed for personal financial management. Since this is my first post I want to give everyone some background information about myself and explain a little about how I plan to develop this blog into a library of resourceful information.

I decided to start a personal finance blog because I often get requests from friends to help them with their finances and through the years I have discovered a TON of people have little to no knowledge when it comes to managing THEIR own money. I strongly believe being financially independent and fiscally responsible is a crucial part to being successful in life, and I want to share my knowledge in an open and interactive way with those who need it.

About two and half years ago I graduated from the University of Central Florida (UCF) with a degree in Finance, upon graduation I was offered a job at a Global 100 company (where I was an Intern), as a Financial Analyst and have been working there since. During that time I began the long road towards earning the Chartered Financial Analyst (CFA) designation (passed level one in December), and was a founding partner of ABL Capital Partners, an investment partnership I started with three friends from school. I graduated from college with no debt and within a little over two and a half years was able grow my net worth about 8x (or 700%)! Keep in mind as a recent college graduate my net worth was not very high to begin with 😉 but, a great feat in my opinion none the less!

Initially I plan to have two types of posts, “What is?” and “Theory & Practice.” “What is?” will be informative posts which explain basic financial topics; “Theory & Practice” posts will consist of basic financial theory including how to implement the theory. Overall I will keep the posts short, to the point, and as informative as possible. I’m sure I will make changes and adapt along the way, but for now keep an eye out for new posts and feel free to leave comments or suggestions.

-Cole