rule of 72

[so1970]

if i understand this correctly its when the interest rate multiplied by number of years equals 72 your money doubles. so why are we not doing something to get the interest rate on our savings up? would it not be better for banks to lend money at higher rates then we would save and invest at higher rates ? or am i missing something?

[souldoubt]

Higher interest rates usually aren't a good idea when the economy is stumbling along. If rates are raised then banks will have a harder time giving out loans, people/businesses who do get loans will have to pay more for those loans and pass the cost along and so on. You can't simply raise rates to create wealth because whle people might get a higher rate of return on their savings account they're paying more for goods and services.

[so1970]

i thought it was getting harder to get a loan any way. wouldn't it give banks more incentive to take the risk of giving loans if their returns would be more? i believe when my parents bought their house in the early 70s interest on their loan was around 10%, but govt bonds were returning a good %rate also.

[phil5185]

or am i missing something?

Yeah. Interest rates are determined by the supply/demand of capital. Eg, if a company wants to sell bonds (borrow money) to expand their business, the lenders (bond buyers) evaluate them. If you offer to pay your lender 3% he might say 'no', company B will give me 5%. And company C will give me 10%. But the investor may not want the 10% bond, too much chance of that company failing and losing his principal. (Eg, I won't buy 10% bonds, I consider them junk bonds - but I like 5% bonds.)

Rule of 72. When 'years' X 'rate' = 72 your money doubles (eg, 9 yrs X 8% gives you a 'double').
It is derived from the natural log base e. 2=e^.72

[so1970]

phil i understand bonds on a supply and demand basis but im trying to figure out how everything being on sale helps the economy? that sentence alone sounds wrong, but if you finance a car to a guy for 0% interest your not making money your just swapping money. so wouldn't banks be stronger with a little more profit margin,therefor be able to offer a better rate of return on savings?

[SVT]

Apr 28, 2011 11:34:11 GMT -5 so1970 said:

phil i understand bonds on a supply and demand basis but im trying to figure out how everything being on sale helps the economy? that sentence alone sounds wrong, but if you finance a car to a guy for 0% interest your not making money your just swapping money. so wouldn't banks be stronger with a little more profit margin,therefor be able to offer a better rate of return on savings?

- "everything on sale" is to entice people to spend their money.

- I'm not aware of a bank that lends money for a car at 0%.

[so1970]

i was just throwing the car out as a example but in the above post i mention my parents buying their house at around 10% interest and govt bonds were paying hefty dividends.

[frep]

Apr 28, 2011 11:23:27 GMT -5 so1970 said:

i thought it was getting harder to get a loan any way. wouldn't it give banks more incentive to take the risk of giving loans if their returns would be more? i believe when my parents bought their house in the early 70s interest on their loan was around 10%, but govt bonds were returning a good %rate also.

I don't think their returns would necessarily be more. As you stated if the interest rate on loans is higher so is the interest rate you can get on your savings.

Right now if they loan money out at 5% and pay 2% on CD rates, that's no net difference than loaning it out at 9% and paying 6% on CD rates.

[Plain Old Petunia]

<< phil i understand bonds on a supply and demand basis but im trying to figure out how everything being on sale helps the economy? >>

Spending is what helps the economy. Low interest rates encourage spending, high interest rates discourage spending.

[so1970]

then again i have seenads for interest rates on a car for 0% interest from gm,ford and chrysler

[Gardening Grandma]

i was just throwing the car out as a example but in the above post i mention my parents buying their house at around 10% interest and govt bonds were paying hefty dividends.

I can recall mortgage rates at 10% and above. And the "hefty" dividends paid by gov't bonds and CD's. That was when inflation was in the double digits. Believe me, I don't want to see that again.

[Plain Old Petunia]

Apr 28, 2011 11:50:11 GMT -5 so1970 said:

then again i have seenads for interest rates on a car for 0% interest from gm,ford and chrysler

That's so you will buy the car. Their profit is built in to the price you pay for the car. A bank does not make a cent when you buy a car, so they aren't going to carry your note at 0%.

[resolution]

The 0% rates on cars aren't being offered by the banks, they are being subsidized by the car builders. I bet if you go into any of those dealers that are offering 0% financing and tell them you want a cash rebate instead, they will have a fixed amount that they will offer you which represents their cost to subsidize the 0% financing.

[runewell]

It is derived from the natural log base e. 2=e^.72

ln 2 = .6931 so I guess you're better off with the rule of 69, bet ppl will find that easy to remember. They probably used 72 because it is divisible by a lot of integers.

[runewell]

Apr 28, 2011 11:50:36 GMT -5 Gardening Grandma said:

I can recall mortgage rates at 10% and above. And the "hefty" dividends paid by gov't bonds and CD's. That was when inflation was in the double digits. Believe me, I don't want to see that again.

Sure your portfolio will double faster, but if inflation is going up faster it looks good until you have to buy something.

[so1970]

wasn't the problem with the housing market that it was easier for people to just default on their loans and walk away because they had nothing invested and banks didn't have enough of a profit margin to survive?

[Plain Old Petunia]

Apr 28, 2011 12:21:16 GMT -5 so1970 said:

wasn't the problem with the housing market that it was easier for people to just default on their loans and walk away because they had nothing invested and banks didn't have enough of a profit margin to survive?

The problem with the housing market was too many people paying much more than they could afford for a house, and financing it with negative amortization loans which eventually have a steep increase in monthly payments.

I put down 20% + closing +repairs out of my pocket, and I have considered walking. If I had put nothing down, it would be that much easier. So yes, there is that.

The profit margin for a bank between prime lending rate and federal funds rate doesn't vary all that much, I think.

[so1970]

so what is it going to take to make this country stronger financially?

[resolution]

Apr 28, 2011 12:40:44 GMT -5 so1970 said:

so what is it going to take to make this country stronger financially?

I think we are going to have to stop spending more than we earn (federal deficit) and stop subsidizing so many random industries at the cost of the consumer (for example sugar subsidies).

[runewell]

Another problem (which comes from material on a soon-cominig actuarial exam) was that banks misestimated the downside of the pools of mortgages and asset-backed securities. Investors were hungry for yield, so they bought a bunch of these "AAA" rated securities that turned out not to live up to their rating. But they were very popular because of their perceived yield and safety level.

[runewell]

Apr 28, 2011 12:40:44 GMT -5 so1970 said:

so what is it going to take to make this country stronger financially?

Reducing spending, some more taxes, bigger cuts, and lower compensation for all of us to compete with those who make less. I expect our standard of living will continue to deteriorate as our jobs go to those much less fortunate than ourselves.

[tskeeter]

If you think about it this way, you'll have a pretty good handle on how our economy is affected by interest.

The payment of interest basically takes money out of the economy. Each of us have a finite amount of money to spend on things like homes, cars, clothes, entertainment, etc. If we pay more in interest, we have less money to actually buy things, so we are not willing to pay as much for what we buy, or we reduce our spending on discretionary items, such as entertainment.

Assume you can afford $1,500 a month in house payments. If interest is $1,000 of your monthly house payment instead of $500, you're probably not willing to pay as much for the house you need to shelter your family. Since the seller of the house didn't get as much from you as he wanted, he's feeling kind of poor. The home seller does not take his wife out to dinner to celebrate the sale of their home. That means that the waiter at the restaurant doesn't get a tip, so he doesn't buy a new stereo and the cook doesn't get the raise he wanted, so he doesn't buy new fancy wheels for his car. Then the electronics store lays off a sales person because the waiters aren't buying stereo equipment and the tire shop lets one of their people go because cooks aren't buying low profile tires and big wheels. The tire shop guy cancels his apartment lease and moves in with his parents because he can't afford the rent. And on, and on.

So turns the world of interest payments.

[ameiko]

Apr 28, 2011 12:47:23 GMT -5 resolution said:

Apr 28, 2011 12:40:44 GMT -5 so1970 said:

so what is it going to take to make this country stronger financially?

I think we are going to have to stop spending more than we earn (federal deficit) and stop subsidizing so many random industries at the cost of the consumer (for example sugar subsidies).

[sunuva]

I look at it from a different perspective.

If banks needed your money they would entice you to give it to them by offering a higher interest rate. If the interest rate is low then banks, simply, don't need your money.

Going further, if banks can make their profits without the use of your money (since they aren't raising interest rates) then where are they getting their money from? If the answer is they are still getting their money from you, they just don't need to involve you on the "savings" side, anymore, then why on earth would you even want to consider wealth building involving banks?

Use a bank for your financial transactions since that is how things are set up, but stay clear of hoping to be able to use them to build wealth. If you want to use the rule-of-72 for easy mental calculations (for doubling your money) then apply it to your own wealth-building strategy outside and apart from banks. This means actually taking more charge of your financial life - that's not necessarily a bad thing.