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- The Rule of 72 is an equation that predicts how long it will take for an investment to double in value or lose half of its value.
- The Rule of 72 is calculated by dividing 72 by the rate of return on an investment or account.
- Only investments that yield compound interest may be employed with the Rule of 72, and it works best with interest rates between 6% and 10%.
It can be intimidating to start learning how to invest in the stock market. However, taking the first step can be a terrific strategy to increase your wealth. How to forecast the growth of your assets when you begin constructing a portfolio is one of the many concepts in investing that you need to comprehend.
What if you could enter a few data points into a straightforward formula to calculate the time it would take for your assets to double?
Exactly that is what the Rule of 72 accomplishes. Here's everything you need to know about how it functions and why it's important to have in your toolkit when investing.
So, what is the Rule of 72?
The Rule of 72 is a mathematical formula that predicts when something will happen.
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%. It can also be used to calculate how it may fall, too.
Just remember that this rule only applies to compound growth or decay. In other words, it can only be applied to investments that generate compound interest rather than just interest. Simple interest just allows you to make interest payments on your principal investment. Compound interest is "interest earned on interest" and is calculated by adding the principal to the accrued interest.
Compounding causes your investment to expand exponentially since interest (i.e., dividends) is basically added to your principal and utilized as the basis for further interest computations. Therefore, when interest builds up and the amount of money rises, the rate of growth quickens.
Compound interest is a benefit that can be obtained from anything that raises your principal, not just investment interest. Your earnings are compounded, for instance, if you reinvest the income you receive on your investments. The Rule of 72 therefore applies.
The Rule of 72 would not apply, however, if you decide to withdraw your profits rather than reinvest them. In this case, your gains might not compound.
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 down here 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 would take for your investments to double.
You'll see the formula uses the "approximately equals" symbol (≈) 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 instance, you can utilize the Rule of 72 to gauge what amount of time it will require for a money's purchasing power to be sliced down the middle because of inflation, or how long it will require for the complete worth of a life insurance policy to decline by half. The recipe works the very same one way or the other — just input the inflation rate rather than the rate of return, and you'll get a gauge for what amount of time it will require for the initial amount to lose half of its value.
Rule of 72 example
Let's say you invest $1,000 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 ≈ 7.8
This means that your initial $1,000 investment will be worth $2,000 in about 7.8 years, assuming your earnings are compounding. If you instead invest $10,000, you'll have $20,000 in just under eight years. This also means that $20,000 will double again in another eight years, assuming the same rate of growth — in other words, you'll have $40,000 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.
Other options to the Rule of 72
The number 72 is a good estimator in most situations and, because it is an easily divisible number, it makes for simple math. 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 play around with it a bit — 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 bottom line
The Rule of 72 give a quick and easy way for investors to forecast 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.
