The Rule of 72 (includes calculator)
“Compound interest is the greatest mathematical discovery of all time”
-Albert Einstein
The Rule of 72 offers an easy method of determining how long it will take to double an investment at a fixed interest rate with compound interest. Compound interest, as you probably know, is the adding of accumulated interest back to your principal, so that interest is earned on interest. Shifting the interest to principal is the compounding effect.
The Rule of 72 says that if you divide the number 72 by the annual rate of return for the investment your answer is a rough estimate for the number of years it will take for your initial investment to double.
Using the Rule of 72
Here is a very simple example of how the rule works. If you invest $100 at 10%, you can expect that initial investment to grow to $200 in about 7.2 years (72 / 10 = 7.2). In reality, it would take just a little bit longer (about 7.3 years) but you can see how the rule can be helpful. At a 6% return, your investment takes 72/6 or 12 years to double.
We can also use the Rule of 72 to find a desired interest rate. Let’s say we have a 12 year timeframe in which we would like to double our money. What interest rate do will we need to make that happen? 72 / 12 = 6%
The Power of Compound Interest
Working with the Rule of 72 can help you to fully appreciate the power of compounding and the impact that a small difference in your rate of return can have on the growth in your investment. For example, if one stock sees 10% growth while another grows at 12%, the Rule of 72 will tell you that the second stock will double in only 6 years as opposed to 7.2 years for the first stock. The advantage of the (even slightly) higher return increases over longer periods.
When you’re dealing with moderately high to low rates of return (20% or less), the Rule of 72 is rather accurate. It does, however, become less precise as rates of return increase. When dealing with higher rates, it’s best to perform the calculations using proven financial formulas.
To summarize, the Rule of 72 offers a convenient means of calculating the interest rate and time required for an investment to double in value leveraging the power of compounded interest.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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