The value of compound interest is the essence of all investments. However, one of the problems with compounding is figuring out just how fast your money is growing. You may look it up in tables or compute it with algebra. Using mathematical shorthand, such as the Rule of 72, provides a quicker answer.

To determine how long any amount of money invested on a compound interest basis will take to double, simply divide the interest rate into 72. If, for example, the money is earning 10% interest, the money will double in 7.2 years:

72 divided by 10% = 7.2 years.

Common interest rate calculations using the Rule of 72 follows:

72 Divided By 12% = 6.0

72 Divided By 10% = 7.2

72 Divided By 7% = 10.3

72 Divided By 5% = 14.4

72 Divided By 3% = 24.0

The rates show above are for hypothetical illustration only, and not indicative of any particular investment.

Investing money at compound interest is one way to make time the ally of a wealth building plan. But time may be the enemy of your investment as well, particularly if general price levels around the country rise faster than the investment pays you back. This wealth-eroding element is known as inflation.

Just as the compounding of earnings builds wealth, inflation deflates it. Compounding interest gives you more dollars, but inflation makes them worth less when you receive them. Inflation can rob investors of everything they hope to gain through the use of compounding. Every investor should know how to hedge against inflation through careful selection of appropriate investments.

Before 1970, few people in this country worried about inflation.

Of course, stories have been told of great inflationary periods. In post World War I Germany, inflation escalated to the point that 500,000 German marks were required to purchase one loaf of bread. High inflation also struck many Central and South American countries during the 1960s and 1970s.

For Americans, those were distant experiences until the late 1970s. Inflation took this country by storm, soaring well into double digits. The menace of inflation finally attracted our attention. Although rebuffed by the monetary recession of the early 1980s, inflation still remains a serious threat. Unless you hedge against it in your investments, you run the risk of earning high interest rates but at very low real rates of return, after inflation.

When calculating the return on an investment, be sure to consider the real rate of return - the true measure of an investment’s future purchasing power. To find the real rate of return, you will need to utilize just two factors:

The nominal interest rate is easy to find. That is the interest you are receiving on the investment.

The rate of inflation is measured by the CPI (Consumer Price Index) published by the federal government, although more sophisticated investors tend to follow the WPI (Wholesale Price Index). To find the real rate of return, simply subtract the annual CPI or WPI from the interest rate you are receiving.

Suppose, for example, you have invested $10,000 and are receiving 9% compound interest. On the surface, it seems as if you have made an excellent investment - with an outstanding return.

But the real rate of return is only relative. If the rate of inflation is 5%, the real rate of return is just 4% (9%-5%=4%). The fact that you are receiving only 4% real rate of return makes most investors take notice. Of course, this is a hypothetical calculation and results will vary based on actual investments and subsequent inflation.

This is complicated further when one considers the effect of income taxation on the hypothetical investment return:

Example 1 Example 2 Example 3

9.0 7.0 5.0 Gross Earnings Rate

30.0 30.0 30.0 Marginal Tax Bracket (state & federal)

6.3 4.9 3.5 Net Investment Return

5.0 5.0 5.0 Rate of Inflation

1.3 -0.1 -1.5 Real Growth Rate

A great many people feel that worrying about inflation is a waste of time. They think that the double-digit inflation of the late 1970s in the U.S. was an anomaly, that it will not return and there is really no reason to worry about inflation for another 40 years. Other countries have sustained far higher inflation, some as high as 25% per year for a period of many years.

However, as we see above, inflation does not have to exceed 5% to have a serious impact on the average person’s investments!

The truth is that inflation has specific economic causes and those causes often reoccur. The high inflation experienced in the 1970s could return. Planning a long-term financial strategy can help avoid the economic erosion of your investments.