Have you ever thought about how long it might take to double your money with interest? The Rule of 72 is a simple trick that can give you a rough estimate.
Understanding the Rule of 72
The Rule of 72 works like this: Divide 72 by your expected annual interest rate (as a percentage, not a decimal). The result will give you an approximate number of years it will take for your money to double.
For example, if your investment earns 4 percent per year, it would take approximately 72 / 4 = 18 years to double.
This rule can also be applied to inflation. Similar to investment growth, divide 72 by the inflation rate (again, as a percentage) to estimate how long it will take for your money’s purchasing power to be halved.
The Rule of 72 is an estimation and is most accurate at around an 8 percent interest rate. The further the interest rate or inflation rate is from 8 percent, the less precise the result will be.
Despite its limitations, the Rule of 72 is a useful tool for quickly understanding how your money could potentially grow over time based on a certain interest rate.
The Formula for the Rule of 72
The Rule of 72 can be expressed simply as:
Years to double = 72 / rate of return on investment (or interest rate)
There are a few important things to keep in mind when using this formula:
- The interest rate should be expressed as a whole number, not as a decimal. For example, 72/7 is 10.3, which means it would take approximately 10.3 years to double your money with a 7 percent interest rate.
- The Rule of 72 focuses on compounding interest that occurs annually.
- For simple interest, you would divide 1 by the interest rate expressed as a decimal. For example, if you have $100 with a 10 percent simple interest rate with no compounding, you would divide 1 by 0.1, resulting in a doubling rate of 10 years.
- For continuous compounding interest, using 69.3 instead of 72 will provide more accurate results. While 72 is easier for mental math, 69.3 is better for precise calculations. If you have a calculator, opt for 69.3 for slightly more accurate results.
- The Rule of 72 works best within the range of 5 to 10 percent interest rates, but it is still an approximation. To calculate based on a lower interest rate, such as 2 percent, use 71 instead of 72. For higher interest rates, add one to 72 for every 3 percentage point increase. For instance, use 74 for a doubling time calculation with a 16 percent interest rate.
How to Apply the Rule of 72 in Your Investment Strategy
Many families aim to continue investing over time, often on a monthly basis. By using the Rule of 72, you can project how long it will take for your compound interest investment to reach a specific target amount, considering your average rate of return and current balance.
For instance, if you have $100,000 invested today at a 10 percent interest rate and you are 22 years away from retirement, you can expect your money to double roughly three times, increasing from $100,000 to $200,000, then to $400,000, and finally to $800,000.
Adjusting your investment strategy based on changes in interest rates or financial needs, such as inflation, can be guided by the insights gained from the Rule of 72.
The Rule of 72 can also help you make decisions regarding risk and reward. Comparing the doubling rate of a low-risk investment with a 2 percent interest rate taking 36 years to double versus a high-risk investment with a 10 percent interest rate doubling in seven years can provide valuable insights.
While younger individuals often lean towards higher-risk investments due to the potential for exponential growth, as retirement approaches, the focus typically shifts towards capital preservation. Prioritizing lower-risk investments ensures a stable source of income in later stages of life.
Using the Rule of 72 for Inflation
Investors can utilize the Rule of 72 to determine how long it will take for inflation to cut their purchasing power in half. For instance, if inflation is at 3 percent, dividing 72 by the inflation rate gives you 24 years until your money’s purchasing power is reduced by 50 percent. Higher inflation rates, like the 8 percent seen in 2023, can halve purchasing power in just nine years.
72/3 = 24 years to halve purchasing power
72/8 = 9 years
The Rule of 72 provides investors with a practical understanding of how inflation impacts their finances. While inflation rates may fluctuate, historical data shows prolonged periods of high inflation significantly reducing the value of savings.
Final Thoughts
The Rule of 72 is a valuable tool for individuals embarking on their investment journey. It emphasizes the importance of early investing, even with modest amounts. Compound interest enables your money to grow exponentially over time, especially with initial investments. Additionally, the Rule of 72 can help you comprehend the effects of inflation. By dividing 72 by the inflation rate, you can estimate how long it will take for your money’s purchasing power to be halved.
Note: Laura Leavitt contributed to this article.