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Some 28 years ago when I first came to Canada my cousin gave me a book called Common Sense the magic of compound interest.

In it was this.

The Rule of 72

Have you always wanted to be able to do compound interest problems in your head? Well, let's be honest - probably not.

However, it's a very useful skill to have because it gives you a lightning fast benchmark to determine how good (or not so good) a potential mortgage note (or any investment) is likely to be. And it's surprisingly easy to do in your head... once you know how.

The rule says, that to find the number of years required to double your money at a given interest rate, you simply divide the interest rate into 72. That's why it's called the "Rule of 72"!

For example, if you want to know how long it will take to double your money at 8% interest, you would simply divide 8 into 72 and you'll get 9 years. This is assuming the interest is compounded annually.

As you can see, the "rule" is remarkably accurate, as long as the interest rate is less than about 20%. At higher interest rates the error starts to become significant.

Of course, you can also run it backwards. For example if you want to double your money in 6 years, just divide 6 into 72 to find that it will require an interest rate of about 12%.

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Here's How Compounding Works

Compound interest pays interest not only on the principal, but on the interest as well, increasing the rate at which your money grows.

For example if the interest was compounded yearly and you started with a $100 investment at a 10% interest rate, you'd have earned $10 interest the first year, and would now have $110 at the end of the first year.

In the second year, you would earn interest on $110, giving you $11 in interest in the second year, so at the end of the second year you would now have $121, and so on. So after 20 years you'd end up with $672.75!
Amral
Compound interest holds incredible implications for those who start to invest early on in life. The sooner one establishes an investment portfolio, the longer that portfolio will have to earn interest. The beauty of "compound" interest is that one will continuously earn interest ON THE INTEREST WHICH THEY HAD EARNED PREVIOUSLY!

So what are the long-term implications of this? Well, establishing an investment portfolio at an early age means one will not need to invest as much money in order to reach their retirement goals as they would if they started later on in life. As an example, imagine two different people who wish to retire at the age of 60.

The first individual starts young. This 15 year-old begins to save his/her summer wages (let's say, $2,500.00) within an RRSP. This individual continues to contribute this same amount for the next 15 years, and then stops at the age of 30. If this investment portfolio received compound earnings at an annual rate of return of 10%, then this individual would accumulate more than $1.5 million by the time he/she reached the age 60. Pretty incredible, especialy when one stops to consider that this individual only invested $37,500!!!

The second individual started contributing the same $2,500 amount every year, but he/she started at age 30. This person would end up contributing over $87,500.00, and would have only accumulated just over $500,000 by the time he/she retired at age 60.

Here's another stunning example of how compounding inside an RRSP pays off over the long term. To reach a nest egg of $275,000 at age 65, a 20-year-old would only have to invest $1,000 for five years at 10% - a $5,000 investment. Meanwhile, a 31-year-old would have to deposit $1,000 for 35 years (a total investment of $35,000) at 10% to accumulate the same amount of money.
Amral
Amber i think the contribution limit is based on earnings. It's only high earners that are usually able to put the maximum anyways.

If you put more than your maximum for that year, it can be carried forward to the next year and you wouldn't be able to get any tax benefit for the contributing year. But if it's invested wisely then the long term results is worth it.
FM

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