Rule of 72
The Rule of 72 is a simple, effective method that is widely used to calculate how many years it takes to double an investment at a certain annual rate of return. It can also calculate the annual rate of compounded return to determine how many years it will take to double an investment.
Although calculators and spreadsheet tools such as Microsoft Excel provide functions for precisely calculating the amount of time required to double an investment, the Rule of 72 is handy for quick mental calculations to approximate a number. The Rule of 72 is commonly taught to novice investors due to its ease of application and calculation. Among tools for financial literacy at the grade level, the Securities and Exchange Commission also mentions the Rule of 72.
The Formula for the Rule of 72
There are two ways to use the Rule of 72 to calculate an estimated doubling period or needed rate of return.
Years To Double: 72 / Expected Rate of Return
Divide 72 by the anticipated rate of return to determine when an investment will double. The calculation is based on a single average rate during the investment's lifetime. All decimals represent an additional fraction of a year, hence the conclusions hold true for fractional outcomes as well.
Estimate Required Rate of Return: 72 / Years To Double
Divide 72 by the amount of time needed to double your money to determine the projected rate of interest. Because the formula can handle fractions or parts of years, the number of years does not have to be a full number. The predicted rate of return also assumes that interest will compound at that rate throughout the life of an investment's holding period.
Note: Compound interest situations, not simple interest situations, are covered by the Rule of 72. Simple interest is calculated by dividing the principal amount and the number of days between payments by the daily interest rate. Both the initial principle and the accrued interest from prior periods of a deposit are taken into account when calculating compound interest.
How Do You Calculate the Rule of 72?
The Rule of 72 operates as follows. You divide 72 by the anticipated yearly return on the investment. The outcome is the approximate number of years it will take for your money to double.
For instance, it will take roughly nine years (72 / 8 = 9) to double the invested money if an investment strategy provides an 8% yearly compounded rate of return. In this equation, a compound yearly return of 8% is entered as 8, not 0.08, resulting in a result of nine years (and not 900).
Suppose it takes nine years to double a $1,000 investment. In that case, the investment will grow to $2,000 by year 9, $4,000 by year 18, $8,000 by year 27, and so on.
- The Rule of 72 is a concise formula that determines how long it will take for the value of an investment to double based on its rate of return.
- The Rule of 72 is applicable to compounded interest rates with interest rates ranging between 6% and 10%.
- The Rule of 72 can be used to determine how annual fees will affect an investment's growth over the long term and can be used for anything that grows exponentially, such as GDP or inflation.
- The rate of return required for an investment to double given an investment period may also be estimated using this estimating tool.
- Use of the Rules of 69, 70, or 73 is frequently preferable in a variety of circumstances.