Heres a formula that i found interesting.
How to spot what’s too good to be true: The Rule of 72
You may have heard the saying ‘If it sounds too good to be true, it probably isn’t true’. But how do you work out what could be too good to be true?
Start with the rate of return you have been offered. Most investments illustrate their rates of return using percentages. While that’s perfectly reasonable, research suggests that many people have trouble working out percentages, especially in their heads.
Use the Rule of 72
One way to tackle this problem is to work out how long it would take to double the money you originally invested if you reinvested all your returns.This is simpler than it seems. Before calculators or spreadsheets, investors used the trusty old ‘Rule of 72’.
How the Rule of 72 works
Suppose you were offered an investment with a return of 10% per year and you reinvested all your returns. How many years would it take to double the value of your original investment?The Rule of 72 says you:
divide 72 by the annual rate of return
to get the number of years it will take to double your money.
So for 10% per year:72 divided by 10 = 7.2
which means at this rate of return, it will take a bit over 7 years to double the value your original investment.If you get a 20% per year return, it will take a shade over 3½ years to double your money. If you get only 3% per year you will have to wait 24 years.
The Rule of 72 is not absolutely precise, but it gives you a practical estimate that you can work out in your head.
A real-life example: the ‘Wattle’ scheme
Let’s use the Rule of 72 in a real case from the ASIC files.The ‘Wattle’ scheme was one of Australia’s worst investment disasters during the late 1990s. More than 3,000 Australians, including police and health care workers, invested about $160 million dollars in an illegal investment scheme that promised 50% per year return, paid each month.
Using the Rule of 72:
72 divided by 50 = 1.5
This would mean that, as an investor in the scheme, you would double your money in less than 1½ years. Sound good? It sounds even more tempting when you realise that you’d double your money again inside another 1½ years.Imagine if you started with $10,000. You’d end up with $40,000 in less than 3 years because you’ve doubled your money twice. Within 10 years, you’d be a millionaire! Your original $10,000 would have multiplied 100 times.
So, who wouldn’t want to be a millionaire?
Before you start dreaming of paying off your mortgage and taking the kids to Disneyland, ask yourself this: Could you safely and seriously expect to make that much money that quickly?Remember, you’re probably not the only person investing in the scheme. If you are getting unbelievable returns, so are all the other investors. Just think — if 3,000 people each put in $10,000 (and many people put in much more), then everyone would be a millionaire after 10 years. The whole scheme would be worth a whopping $3 billion, a scheme as large as one of the top 50 companies on the Australian sharemarket. Common sense should tell you that something about these numbers doesn’t add up!
What the Rule of 72 says
The Rule of 72 indicates that this scheme does sound ‘too good to be true’.As it happens, the Wattle scheme turned into a disaster for investors. While it supposedly made profits for investors by lending funds to new businesses, the Wattle scheme was really a Ponzi scheme that paid investors out of its own capital, not from the profits it was earning. ASIC got the scheme closed down and the man running it has been sentenced to ten years jail, subject to appeal.
By using the Rule of 72, you can find out if an investment return really is ‘too good to be true’, and avoid being taken in by scams.
And if your interested in the Wattle scheme here is the link, and also another scheme known as the Ponzi scheme. [V]
http://www.fido.asic.gov.au/fido/fido.nsf/byheadline/Ponzi+schemes?openDocument
I Recall Noel Whittaker talking about the rule of 72 as applied to investments many, many years back [
]REDWING
“Money is a currency, like electricity and it requires momentum to make it Effective”
The formula is only correct if one were not required to pay tax on one’s profits.
Therefore the best tax vehicle really is one’s own house.
Once one has some sizeable equity in one’s own home consider replacing it with another home which you may be able to buy below market or where you can improve the value by making renovations.
The ‘profit’ on the first house is tax free.
Pisces
Pisces..
a quick question, what would be the minimuim amount then, in equity that you would consider a PPOR had appreciated enough to be able to sell and realise a profit, taking into account purchasing, holding, and selling cost’s ??
Or rather than equity as a dollar figure how about expressed as a percentage of the purchase price..??
I know it’s like asking how long is a piece of string, but in ‘your’ opinion..?
REDWING
NG
“Money is a currency, like electricity and it requires momentum to make it Effective”
Gee, you are putting me on the spot here as everyone has different criteria.
Personally I would judge that an increase in value of between $ 100 K to $ 200 K should be ample to start thinking of cashing in and putting some non taxable money into one’s pockets.
I guess one way of looking at things is that if one were in a position to sell one’s home for say a profit like mentioned above AND at the same time one is able to replace it with a suitable home in the same market say 15% below market value (or a house which one will be able to add value to by undertaking some renovations) one would be doing extremely well and it looks to me a foregone conclusion for many people as to what decision they ought to consider making.
One problem one may enounter is objection by one’s partner who may look at the home in a different light, in a, what shall we call it, a more emotional way.
The decision to sell and replace it with another home depends totally on the individual’s position and outlook.
Pisces
Originally posted by Pisces:The formula is only correct if one were not required to pay tax on one’s profits.
Therefore the best tax vehicle really is one’s own house.
Once one has some sizeable equity in one’s own home consider replacing it with another home which you may be able to buy below market or where you can improve the value by making renovations.
The ‘profit’ on the first house is tax free.
Pisces
Pisces,
The profit on EvERY house is tax free if you never sell.. simple refinance and use the money to purchase further property.
Why complicate a pretty simple process?
Same as the whole “11 second rule”, and line after line of calculations….
The 11 second rule is simply a gross yield of 10.4%…Isnt that much simpler?
Jay.
Hi Jay, I noticed that this is your first post on this site. Welcome.
Your post made me sit up and question what I said earlier on.
You said : “The profit on EVERY house is tax free if you never sell.. simple refinance and use the money to purchase further property.”
Firstly it is one way to ‘step up’, going from one house to a better house (in a better neighbourhood perhaps or to a larger house or to a house in the same neighbourhood but with say a view) and one is even able to repeat this process several times over a number of years.
How else does one get into a position to improve one’s own home without putting pressure onto oneself by taking on a larger loan ?
Secondly it enables one to put some C-A-S-H into one’s pocket without incurring a tax liability.
Thirdly one may even be able to ‘retire’ some of one’s (own) homeloan debt. That doesn’t mean of course that one cannot borrow on the new home (to buy an investment property).
Fourthly, if one is prepared to accept the inconvenience of moving house in order to obtain non taxable CASH as well as buy a replacement house below market value, isn’t one better off than taking on a loan (or increasing one’s present (own) home loan to ‘step up’?
Fifthly, I see some problems in retaining the present own home and turning it into an investment property
if ever the time does come that one (for one reason or another) were to decide to sell that particular property.It looks to me as if one may well have a problem with the taxation department on one’s hands as far as the taxfree dollars, which are presently locked into the property, are concerned.
Perhaps I am a little bit too paranoic there ? I just think it nice to have a clear cut situation there, not some fuzzy situation which may cause a dispute.
I would however very much welcome other people’s point of view about the subject !!
Pisces
Pisces,
“Therefore the best tax vehicle really is one’s own house.”
I would argue that because PPOR mortgage rpts are made with after tax dollars, outside of RE booms, an IP is a better tax vehicle.
Bruce
Mooloolaba, Qld>>I would argue that because PPOR mortgage rpts are made with after tax dollars, outside of RE booms, an IP is a better tax vehicle.<<
Look at it this way Bruce, you’ve got to live somewhere, nothing can change that.
So cashing in and moving onto the next one can be a very profitable venture.
Pisces
Originally posted by Pisces:
The formula is only correct if one were not required to pay tax on one’s profits.Pisces, I disagree slightly with you here. The formula can be correct if you take into account the return you are expecting ‘after tax’. If you expect a 14% return (nice[
]), and you’re in the top tax bracket, you just halve it to 7% and work out the no. of years then.Cheers
MelMel, I think we both are saying the same thing so there isn’t any disagreement, slightly or otherwise.
As you say, the problem doesn’t lie in the formula other than in the way it is applied (or should that read ‘misapplied’ ?).
Pisces
Semantics I think Pisces.
I guess I was merely ‘restating’ your viewpoint but in terms of using the rule.[
]Cheers
Mel
]
]), and you’re in the top tax bracket, you just halve it to 7% and work out the no. of years then.You must be logged in to reply to this topic. If you don't have an account, you can register here.
