I am going to sprinkle in some basic financial concepts into my blog that I feel like will be helpful. Up this week: the Rule of 72.
What is the Rule of 72?
Have you ever wondering how long it will take to double your money on an investment? Look no further! An easy way to remember how to calculate this is the Rule of 72. It is pretty simple really. You calculate it one of two ways:
1. You divide 72 by the average yearly return you expect your investment to make to get the number of years it will take to double your money
- For example, you have a strategy that you expect to return 10% per year. 72/10= 7.2 years until you double your investment.
2. You divide 72 by the number of years you want it to take to double your investment to find the average yearly return you will need in order to do so.
- For example, you would like your investment to double in 5 years. 72/7 = 14.2% return to double your investment in 5 years.
Not just for investing
This formula can be used for anything that has a compound growth rates, not just investing. Other examples can be population growth, charges, or loans. It can also be used understand the effect of fees. For example, if you have a debt that charges 18% annual interest, it will take approximately 4 years for your charge to double if you do not make any payments.
It can also be used to understand the effect on inflation. If you decide to keep all your money in cash and inflation is averaging 3%, in 24 years your cash will be worth about half as much.
Changing the Time Period
What if you want to use a different time period (such as months, quarters, etc)? No problem. You still use 72 but you adjust your inputs to reflect the new time period. If you want to know how long it will take you to double your money by growing at 1.2% per month, you take 72 / 1.3% to get 55 months or 4.6 years to double.
Keep in mind that using the rule will not give you an exact result. It should only be used for approximate purposes. I just wanted to throw this out there in case there is anyone (*cough* nerds *cough*) out there wanting to challenge me on this. Go back to checking your hypotanuses.
One more note on the accuracy; the Rule of 72 is most accurate when using interest rates between 6-10%. For interest rates outside of this range, add/subtract 1 from 72 for every 3% of interest rate difference. So if you are using a 15% rate of return, you should use 74 instead of 72. The difference is marginal but want to be sure I cover my bases.
Tuck this concept away in the back of your hat to pull out the next time your friend says their investments will never double. First ask them their rate of return. If this makes you reply, "that's all?" Feel free to pass them my info.