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The Good Old Rule Of 72

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Want to know how long it takes to double your investments?

Look no further than the old "Rule of 72."

While no one has a crystal ball, this metric helps to figure out the length of time required to double your money at a given rate of return, reflecting the power of compound interest. All you have to do is divide the rate you want to achieve into 72.

Recently, I heard two people talking about this -- a client telling me their goals, and a close family friend teaching my children about the rule. For my client, they wanted to double their nest egg in the next seven years, implying that a 10 per cent annual rate of return was needed. For my kid, they wanted to double their money in the next few months.

While my child's aspirations are not possible without the binary risk of a roulette wheel, my client's -- despite being quite tough -- are. However, it is important to note that while any one investment could theoretically achieve this, the risk is quite high.

If you manage to time things perfectly and pick the bottom of the stock market for instance, you may come close. The S&P has given investors an annualized return of over 13 per cent since February 2009. Yet, if you go back prior to the financial crisis (January 2007), investors had to endure a 50+ per cent pullback, generally receiving returns in the range of 4.5 per cent instead. Historically this has happened many times, and it is important to remember that when looking to the future, a 50 per cent drop in value requires a 100 per cent gain to break even.

So while doubling your money in seven years is an ambitious yet achievable goal, is it prudent given the sheer amount market risk taken on? The answer is yes.

Through proper portfolio diversification and the use of non-correlated investments, investors can achieve this lofty goal while protecting themselves from market volatility. For illustrative purposes, solely adding 35 per cent of a commodity trading advisor (CTA) index such as the AMFERI to the S&P during the financial crisis would have gotten my clients half way back to their goal at 7.4 per cent annualized while also reducing the drawdown from 52.5 per cent to 23.7 per cent. This is but one change that could help investors eliminate the risk of an insurmountable yet all too inevitable pullback.

My advice? Not all diversification is the same. You need more than the long-term, low or non-correlated investments that are generally talked about within the industry. An investment strategy and portfolio requires negatively correlated products as well, especially at certain points in a cyclical market. This is what CTAs do -- they provide investors with products that offer solid performance in times of need.

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