HE-562
INPERSPECTIVE
CONSUMER & FAMILY RESOURCE MANAGEMENT
COOPERATIVE EXTENSION SERVICE, PURDUE UNIVERSITY, WEST LAFAYETTE, INDIANA 47907
THINK REAL DOLLARS THE RULE OF 72
by Dixie Porter Jackson, Extension Specialist, Consumer Economics
The Rule of 72 is a useful tool to help consumers detetermine the impact inflation will have on their income and investments. The Rule of 72 gives an estimate of when the purchasing power of fixed incomes (pensions, annuities, child support payments) will be cut in half, given a certain rate of inflation. The Rule of 72 also can give us an estimate of how long it will take a lump-sum investment to double in value, given a certain rate of return.
Real Dollars
Is a dollar today worth the same as a dollar to be received in 10 years? Most of us who have seen prices rise rapidly in the last few years know the answer to that question is NO! When we think about future dollars, we want to know how much those dollars will buy in terms of today’s dollars. We will call today’s dollars real dollars.
Fixed Incomes
Consumers who are totally or partially dependent on fixed income sources are particularly vulnerable to inflation. This group of consumers includes those who are retired and receiving a fixed number of dollars from a pension fund or an annuity and single parents who are receiving a fixed
dollar amount for child support. Fixed means that the dollar amount remains the same and does not increase with inflation. Therefore, as prices of goods and services rise, that fixed dollar amount will purchase less. The dollars will have less real purchasing power.
John and Mary Blair receive a fixed pension of $700 per month. The Rule of 72 can help them determine just how rapidly the purchasing power of their fixed pension is being decreased by inflation. The steps they must follow are:
•	They must decide what they think is a realistic annual inflation rate for the next few years. They might use last year’s inflation rate or they might use the average inflation rate for the last few years.
•	Suppose they decide that an average annual inflation rate of 9% is a realistic projection. Simply divide 72 by 9. The answer is 8 years. This means that in 8 years, assuming an average yearly inflation rate of 9%, their $700 fixed income will buy what $350 will buy today.
Mr. and Mrs. Blair may want to do several estimates, one for extreme inflation (the 13.5% inflation rate experienced in 1980) and one for a more conservative inflation rate.