- The Rule of 72 is a mathematical formula that estimates how long it will take an investment to double in value or to lose half its value.
- To calculate the Rule of 72, you divide the number 72 by the rate of return of an investment or account.
- The Rule of 72 can only be used on investments earning compound interest; it’s most effective on interest rates between 6% to 10%.
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Learning where and how to invest is intimidating. So intimidating that many people don’t make it to the next step of figuring out how to project the growth of their investments â€” even though that’s pretty crucial to your making financial plans and setting goals.
What if you could plug some numbers into a simple formula and find out how long it would take for your investments to double?
That’s exactly what the Rule of 72 does. Here’s what you need to know about how it works and why it’s a key tool to keep in your investing toolbox.
What is the Rule of 72?
The Rule of 72 is a mathematical principle that estimates the time it will take for an investment to double in value. The mention of maths might make your jaw clench, but the Rule of 72 is actually a very basic formula that anyone can use.
Simply take the number 72 and divide it by the interest earned on your investments each year to get the number of years it will take for your investments to grow 100%. Or to drop by 50%.
However, you can only apply this rule to compounding growth or decay. In other words, you can only use it for investments that earn compound interest, not simple interest. With simple interest, you only earn interest on the principal amount you invest. Compound interest is “interest earned on interest”: It accrues on accumulated interest, in addition to the principal.
Because interest is essentially being added into your principal, and used as the base for fresh interest calculations, compounding makes your investment grow exponentially. Meaning: As interest accrues and the quantity of money increases, the rate of growth becomes faster.
It doesn’t have to be investment interest; anything that augments your principal creates “the magic of compounding.” For example, if you reinvest the dividends you earn on your investments, your earnings are being compounded. Therefore, the Rule of 72 applies.
On the other hand, if you choose to withdraw your dividends rather than reinvest them, your earnings might not compound, and the Rule of 72 wouldn’t work.
How to calculate the Rule of 72
To calculate the Rule of 72, all you have to do is divide the number 72 by the rate of return. You can use the formula below to calculate the doubling time in days, months, or years, depending on how the interest rate is expressed. For example, if you input the annualized interest rate, you’ll get the number of years it will take for your investments to double.
The formula is as follows: t â‰ˆ 72 / r
- t = number of periods it will take for the investment to double
- r = the interest rate or rate of return per period, expressed as a percentage
You’ll notice the formula uses the “approximately equals” symbol (â‰ˆ) rather than the regular “equals” symbol (=). That’s because this formula offers an estimate rather than an exact amount, and it’s most accurate when used on investments that earn a typical rate of 6% to 10%.
While usually used to estimate the doubling time on a growing investment, the Rule of 72 can also be used to estimate halving time on something that’s depreciating.
For example, you can use the Rule of 72 to estimate how many years it will take for a currency’s buying power to be cut in half due to inflation, or how many years it will take for the total value of a universal life insurance policy to decline by 50%. The formula works exactly the same either way â€” simply plug in the inflation rate instead of the rate of return, and you’ll get an estimate for how many years it will take for the initial amount to lose half its value.
Rule of 72 example
Let’s say you invest $US1,000 at a 9.2% annual rate of return, which is the average stock market return for the last 10 years. To calculate the doubling time using the Rule of 72, you’d input the numbers into the formula as follows:
72 / 9.2 â‰ˆ 7.8
This means that your initial $US1,000 investment will be worth $US2,000 in about 7.8 years, assuming your earnings are compounding. If you instead invest $US10,000, you’ll have $US20,000 in just under eight years. This also means that $US20,000 will double again in another eight years, assuming the same rate of growth â€” in other words, you’ll have $US40,000 in less than 16 years.
All of this is also assuming you’re not adding to your initial investment over time, which makes the fact that your money is doubled in less than a decade all the more impressive.
Alternatives to the Rule of 72
The number 72 is a good estimator in most situations and, thanks to it being an easily divisible number, it makes for simple maths. It’s best for interest rates, or rates of return, between 6% to 10%. Most investment accounts, including retirement accounts, brokerage accounts, index funds, and mutual funds fall into this range of return.
But with a different range, you might want to fiddle a bit â€” same formula, but different numbers to divide by. An easy rule of thumb is to add or subtract “1” from 72 for every three points the interest rate diverges from 8% (the middle of the Rule of 72’s ideal range).
At really high interest rates, for example, using the number 78 will give more accurate results. On the other hand, 69 or 70 are more accurate for lower interest rates and interest that compounds daily. Daily compounding is rare in investing and mostly happens with savings products such as high-yield savings accounts and certificates of deposit (CDs).
The financial takeaway
The Rule of 72 offers a quick and easy way for investors to project the growth of their investments. By showing how quickly you can double your money with minimal effort, this rule beautifully demonstrates the magic of compounding for building wealth.