The Rule of 72 is a strategy that helps you determine how long it will take to double your money after investing it into stocks, bonds, mutual funds, or other assets. The calculation associated with this rule depends on your annual rate of return.
Read on to learn more about the Rule of 72, the formula behind it, and how to use it.
What is the Rule of 72?
Investing can be a complex endeavor, but the Rule of 72 isn’t. This method helps investors determine how long it will take for their initial investment to grow over time.
This strategy has increased in popularity within the financial sector thanks to the quick nature of its computation.
How the Rule of 72 works
The Rule of 72 has a simple procedure; you take the number 72 and divide it by your investment's projected annual return. The product is the amount of time that it will take to double your money.
The rule requires a fixed interest rate. It also works best when estimating values over a long period since a shorter time frame and market volatility can make your earnings fluctuate.
Rule of 72 formula
Unlike some financial equations, the Rule of 72 is a pretty straightforward formula; all you have to do is fill in the blanks.
72 / interest rate = years to double
This simple formula applies to any entity that grows in conjunction with exponential growth or, in other words, compounding interest rates — not simple interest rates.
Interest rates represent the rate of return that you’re expected to earn on a particular investment. Compound interest stems from one's principal deposit and the interest that accumulates each day. Simple interest calculations only come from the principal deposit. Population rates, loan rates, and an economy's Gross Domestic Product (GDP) are just a few cases where compounding interest is relevant.
Inflation rates can also shift the formula. Inflation occurs when the prices of goods and services rise. As a result, your money buys less. To account for this phenomenon, simply divide 72 by the current inflation rate. The resulting number represents the number of years that it will take for the value of your money to be cut in half, meaning — in other words — that you will only be able to buy half as many goods.
Technological platforms often have this formula built into them, such as Microsoft Excel, so you don’t have to worry about the calculations. Multiple online calculators can help you as well. But it’s always a good idea to familiarize yourself with the process as it increases personal understanding.
How to use the Rule of 72 for your investment planning
Most people aim to invest monthly, so this rule will help you project how long it takes to accumulate a set amount if you already know your average rate of return and current balance. This finance formula acts as a guideline to help you both set and achieve long-term goals by providing you with a rough estimate of when your initial investments will pay off.
Rule of 72 FAQs
Who came up with the Rule of 72?
In 1494, Luca Pacioli wrote a book entitled “Summa de Arithmetica” which included earliest theories that compose the logic behind this rule. Pacioli took note of money’s tendency to double within specific timeframes, but only briefly describes it in his work. While Pacioli was known as the Father of Accounting, many actually credit the rule’s discovery to none other than Albert Einstein.
How accurate is the Rule of 72?
Once more, the Rule of 72 is an estimated growth rate, so don’t expect completely accurate results. It’s fairly reliable but less accurate as rates of return climb. It’s an adjustable formula for simplicity’s sake. For more exact results, you would need to use the more complex formula, which is the following:
T = (ln(2)) / ln(1 + r/100)
T represents the time it takes to double. ln represents the mathematical function of a natural logarithm (or natural log), and r is the compounded interest rate per period. The numerator contains the logarithmic function, and the denominator substitutes “r” to calculate T.
If your investment earns a 5 percent return rate each year, you would input 5 in this spot.
What is the difference between the Rule of 72 and the Rule of 73?
The Rule of 72 caters to interest rates or investment return rates ranging between 6 and 10 percent.
Since the Rule of 72 grows less accurate as interest rates climb higher than 10 percent, a general rule of thumb recommends adding or subtracting 1 from 72 for every 3 percent that your interest rates differ from a benchmark threshold of an 8 percent rate of return.
An interest rate of 8 percent is used because it occupies middle ground; it’s low enough to help maintain accuracy within calculations, but close enough to 10 that it can help account for higher rates.
If you had a higher interest rate of 12 percent, use the Rule of 73 instead to determine how long it takes to double your money. If you have lower interest rates, like a 5 percent interest rate, you’d divide your total by 71 instead.
At its most basic, the Rule of 72 is a simplified mathematical rule of thumb that helps people handle and keep track of their wealth. Its purpose is to help you plan for the future; that said, there are other strategies you can adopt to plan for the future, such as designing a budget, setting up a retirement fund, and using the right banking card that doesn’t endow you with ongoing fees.
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