What is the ‘Rule of 70’ in finance?
As individuals, we strive to make informed decisions about our financial lives. One crucial aspect of personal finance is understanding the impact of inflation on our money. Inflation, in simple terms, is the rate at which prices for goods and services are rising. It affects the purchasing power of our money, meaning the same amount of money can buy fewer goods and services over time. To estimate the future buying power of money, a useful guideline known as the ‘Rule of 70’ is employed. In this blog post, we will delve into what the ‘Rule of 70’ is, how it works, and its implications for our financial planning.
Understanding the ‘Rule of 70’
The ‘Rule of 70’ is a simple yet powerful tool used to estimate the number of years it takes for the value of money to halve due to inflation. The rule states that when you divide 70 by the inflation rate, you get the number of years it will take for the purchasing power of your money to decrease by half. For instance, if the inflation rate is 4%, dividing 70 by 4 gives you 17.5 years. This means that at an inflation rate of 4%, something that costs ₹100 today would cost approximately ₹200 in 17.5 years, indicating that the rupee would lose half of its purchasing power.
How the ‘Rule of 70’ Works
The ‘Rule of 70’ provides a straightforward way to understand the corrosive effect of inflation on our money. Here’s a step-by-step explanation of how it works:
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Determine the Inflation Rate: The first step is to know the current inflation rate. Inflation rates can vary significantly over time and between different economies. For the purpose of this calculation, you can use the average annual inflation rate expected over the period you’re planning for.
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Apply the Rule: Once you have the inflation rate, you simply divide 70 by this rate. The result is the number of years it will take for your money to lose half its value.
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Interpret the Result: The outcome of the division gives you a clear picture of how inflation will erode the purchasing power of your money over time. This can be a sobering realization, especially for those who are saving for long-term goals without adjusting for inflation.
Example and Implications
Let’s consider an example to make this concept more tangible. Suppose the current inflation rate is 5%. Using the ‘Rule of 70’, we divide 70 by 5, which equals 14. This means that at a 5% inflation rate, the value of your money will halve in 14 years. If you have ₹100 today, in 14 years, you would need approximately ₹200 to purchase the same amount of goods and services that ₹100 can buy today.
This example highlights the importance of factoring inflation into our financial planning. For long-term savings goals, such as retirement or a child’s education, understanding how inflation will impact the value of your money is crucial. It underscores the need for investments that can outpace inflation, ensuring that your savings maintain their purchasing power over time.
Financial Planning with the ‘Rule of 70’
The ‘Rule of 70’ serves as a valuable tool for financial planning, especially when considering investments and savings strategies. Here are a few key takeaways:
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Inflation-Adjusted Savings Goals: When setting long-term savings goals, it’s essential to adjust your target amounts for inflation. Using the ‘Rule of 70’ can help you estimate how much more you’ll need in the future to achieve the same standard of living.
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Investment Choices: The ‘Rule of 70’ can also guide your investment decisions. Since the goal is often to grow your wealth at a rate that exceeds inflation, understanding the impact of inflation can help you choose investments that are likely to achieve this.
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Regular Review and Adjustment: Financial plans should not be static. Regularly reviewing your savings and investments in light of current inflation rates can help you make necessary adjustments to stay on track with your goals.
Conclusion
The ‘Rule of 70’ is a simple, effective way to understand the impact of inflation on the buying power of money. By dividing 70 by the inflation rate, individuals can estimate how many years it will take for their money to halve in value. This rule has significant implications for financial planning, underscoring the importance of adjusting savings goals for inflation and choosing investments that can outpace it. As we navigate the complex world of personal finance, tools like the ‘Rule of 70’ provide valuable insights that can help us make more informed decisions about our money.
For more information on personal finance rules, including the ‘Rule of 70’, you can visit: https://www.news18.com/amp/business/savings-and-investments/from-rule-of-72-to-20x-life-insurance-9-must-know-money-rules-for-financial-security-ws-l-9554756.html
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