What is Rule 72 & How it Works in Investing

The Rule of 72 is a simple and widely employed rule for determining an investment's doubling period. This method provides a simple way to calculate how long it will take your money to double based on a set annual rate of return. While the Rule of 72 is simple, it is also quite flexible, applicable to a wide range of financial situations, and can assist in making sound investment decisions. Let us look in detail at the subtle aspects of the Rule of 72, including its accuracy, uses, and limitations, giving you vital insights to improve your investment plan.

What is Rule of 72?

The Rule of 72 is a financial principle that estimates how many years it will take for an investment to double in value at a particular yearly rate of return. To estimate the time, it will take for the investment to double, divide 72 by the annual rate of return. This rule provides a straightforward way to determine how different rates of return affect the growth of your investment.

For example, if you invest in a financial instrument with a 9% annual return, you may use the Rule of 72 calculator to find out how long it will take for your investment to double.

Years to Double = 72/(Rate of Return)

In this scenario, 72 divided by 9 equals 8 years.

How can you use the Rule of 72?

To use the Rule of 72, divide 72 by the yearly interest rate or estimated return on your investment. The outcome is the approximate number of years required for your investment to double.

This basic computation may be utilised in a variety of financial settings, including determining the growth potential of a savings account, mutual fund, or other investment vehicle. Furthermore, the Rule of 72 can help you assess different investment possibilities and make more informed decisions about where to invest your money for optimal growth. The Rule of 72 is especially important for financial and retirement planning. Understanding how long your money will take to grow allows you to create realistic goals and deadlines for attaining your financial objectives.

Rule of 72 Formula

The Rule of 72 formula is:

Years to Double = 72/(Annual Rate of Return)

This formula is simple and easy to use, making it accessible to most investors. The value of 72 is used because it is conveniently divisible by many numbers, which simplifies mental calculations.

Calculation Table

This table shows how the Rule of 72 provides a useful and somewhat accurate estimate for an array of interest rates, particularly those between 5% and 10%. As rates rise, the Rule of 72 loses some accuracy, but it remains a handy tool for fast calculations.

Does the Rule of 72 Work for Stocks?

The Rule of 72 can be used to forecast how long it will take to double your money in stocks, but it works best when the rate of return is consistent. Because stocks often have unpredictable returns, the Rule of 72 may not always be applicable to stock investments. However, you may use it to calculate the average yearly return necessary to double your investment in a specific time frame.

For example, to double your money in ten years, you can rearrange the Rule of 72 formula:

Rate of Return = 72/Years

So,

72/10 = 7.2%

To double your investment in ten years, you would need to earn an average yearly return of around 7.2%.

What Are 3 Things the Rule of 72 Can Determine?

1. Time to Double Investment: Divide 72 by the yearly rate of return to see how long it will take for your investment to double.
2. Required Rate of Return: If you know when you want to double your investment, you can use the Rule of 72 to calculate the rate of return required.
3. Time to Quadruple Investment: To determine how long it will take to quadruple your investment, simply twice the time it takes to double it. For example, if an investment doubles in eight years, it will take around 16 years to quadruple.

Advantages and Disadvantages of Rule of 72

Advantages

• Simplicity: The Rule of 72 is straightforward and easy to use, making it ideal for fast calculations.
• Quick Estimation: It offers a fast way to determine how long it will take for an investment to double.
• Versatility: It can be used for a variety of financial situations, including investments, inflation, and interest rates.

Disadvantages

• Accuracy: The Rule of 72 is less accurate at extremely high or low rates of return. For more precision, you may need to apply the Rule of 69.3 or different strategies.
• Fixed Rate Assumption: It assumes a constant rate of return, which may not be appropriate for all investments, particularly stocks.
• Not Suitable for Simple Interest: Because the rule is primarily developed for compound interest, it may not be applicable to simple interest investments.

Conclusion

The Rule of 72 is a useful tool for investors who want to quickly predict how long it will take for an investment to double. While it is a helpful estimation, keep in mind that it is most accurate for return rates ranging from 5% to 10%. Consider applying the Rule of 69.3 or other detailed financial calculations with greater precision, particularly at a high rate of returns. Understanding how to utilise the Rule of 72 will help you make better investment decisions and set realistic financial objectives.