Thanks to the power of compound interest, your money can grow substantially over time. It's even possible for that money to double, and you wouldn't have to do a thing.
Do you want to know a really cool trick to figure out just how fast your money could grow? With the "Rule of 72" you can approximate how many years it will take for your money to double, given an estimate fixed rate of return. It takes like 30 seconds!
If you are thinking about saving for your future, the "Rule of 72" can give you an idea of how many doubles you'll get in your lifetime. More time means you might get away with lower interest rates. With less time, a higher interest rate becomes more critical.
Now, you all know I am a number junkie. I use this formula all the time in my personal life to play the "what if" game. What if I earn 5% on my investments? What if I want to retire in 10 years? How many times can my money double before I retire?
BUT the really cool thing is, you can play this game with other interest rates besides just an estimate of what you will earn on your investments. How about a credit card's interest rate? You can actually figure out how long it will take for a credit card company to earn double YOUR money. Of course, that means the higher the interest rate, the more you'll owe to your lenders.
What is the Rule of 72 and Why Does It Matter?
Every investor has the same basic question: how much money can I expect in return, and how long will it take? The Rule of 72 is a simple mathematical formula you can use to estimate how long it will take to double your investment.
Whether you’re investing in stocks, bonds, or even CDs (Certificates of Deposit), the Rule of 72 can be applied!
How Does the Rule of 72 Work?
It’s simple! The equation can be best described as:
72 ÷ interest rate = how long it will date to double your investment.
Some investments, such as CDs and fixed annuities, have fixed interest rates. Simply use that rate for the equation. Other investments like the stock market, however, have variable interest rates. Historically, the 30-year return of the S&P 500 has been around 12 percent. More conservative investors might want to use 8 or even 6 percent for their calculations.
It’s important to note that the interest rate should not be converted into decimal format as it would be in other equations.
Let’s walk through an example together.
If you’re invested in mutual funds and are averaging an annual interest rate of 12 percent, it would take you 6 years to double your investment.
72 ÷ 12 = 6.
If you enjoy math and want to dig deeper into investment performance, you can also modify the Rule of 72. One of the most common variations is to simply reverse the equation.
72 ÷ Desired Years to Double Investment = Annual Interest Rate Needed
This modified version of the equation is good if you have a long term savings goal. For example, if you’re saving for a down payment of a house, saving for your children’s college tuition, or saving for retirement, this equation can show you what interest rate you’ll need to reach your goals.
Below is a table showing the Rule of 72 in reverse.
Why Does the Rule of 72 Matter?
Whether you’re a new investor or a seasoned veteran, the Rule of 72 demonstrates the power of compound interest. After all, the point of investing is to put your money to work for you! There are many reasons why the Rule of 72 is one of the most popular equations in financial management:
Amid all the investment calculators and equations out there, all you need is the basic Rule of 72 to predict your investment performance. You can utilize this equation to assess how long it will take your investments or debts to double!
What New Investors Should Know About the Rule of 72
The Rule of 72 is an excellent rule of thumb to estimate how long it will take for your investment to double.
Of course, there is never a one-size-fits-all solution. We all have different financial circumstances, goals, and projected returns on investments. Partnering with a licensed financial advisor who has your best interest at heart is key to truly maximizing your financial potential.
View the Rule of 72 as a “jumpstart” to understanding investment performance and how long it will take you to achieve your goals. However, at the end of the day, the Rule of 72 can only work in your favor if you’re living on a balanced budget! As fun as it is to calculate equations, the only surefire way to achieve your financial goals is to work towards them, step by step.
Are you paying off your debt? Are you living within your means? Are you investing a little bit of your income every paycheck to save for the future? Continue to practice good financial habits to make sure that the Rule of 72 works for you!