A review of the Rule of 72

This refresher is designed to both promote the use of, and inject a little sanguinity into, the Rule of 72.

rule_of_72

The Rule of 72 is a handy tool to approximate the time it takes to double your money.

Here’s a little refresher on the Rule of 72. It’s called that because, roughly speaking, if the product of the interest rate you invest at and the number of years you invest equals 72, you will double your money in that time.

Take, for example, a nine-per-cent investing rate for eight years. Since nine times eight equals 72, you know that the money you put into that investment will double in that time. Invest $100,000 at nine per cent for eight years, and you’ll end up with approximately $200,000.

Same goes for investing at eight per cent for nine years, since eight times nine also equals 72. Or 7.2 per cent for 10 years; six per cent for 12 years; and so on.

The Rule of 72 is handy in a pinch

You can use the Rule of 72 when you don’t have a calculator or spreadsheet handy, to estimate how much an amount of money will grow in a certain period of time.

But you can also use it in reverse: to figure out that if you need a certain amount of money down the road, here’s how much you need to set aside today, and at what rate it will need to grow, in order for you to meet your goal. For example, if you need $200,000 10 years from now, you’ll need to set $100,000 today and grow it at 7.2 per cent to hit your target amount 10 years from now.

Note that we have used the terms ‘roughly’ and ‘approximately’ in the above descriptions. That’s because, when the interest rate and the term of the investment get farther apart from each other, the Rule get less and less accurate. For example, the Rule suggests that investing at three per cent for 24 years will double your money in that time. But actually, it will only take 2.93 per cent to double your money in 24 years, and at two per cent only 35 years.

And don’t get us started on compounding the return more than once per year. If you assume semi-annual compounding, for example, the Rule instantly becomes less accurate.

In the end, the Rule of 72 is a convenient but rough guide to estimating lump sum present and future values, required returns and investment horizons. Use it to impress your friends. Just remember it has its limitations, as do all generalizations.

This is an edited version of an article that was originally published for subscribers in the July 30, 2021 issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

Comments are closed.