If you want to know how long it will take for your money to increase by a multiple of two, then you need the Rule of 72. A straightforward mathematical instrument, the Rule of 72 is an easy calculation used by investors to figure out roughly how many years it will take for their money to double.
This principle is no-nonsense and a great boon to anyone who wants to practice prudence when it comes to financial decision-making. Employing the Rule of 72 can keep you out of all sorts of fiscal mischief like making unwise investments or succumbing to flashy offers from credit card companies.
So how do you apply this elegantly simple tool to your finances?
How to Use the Rule of 72
In finance, compounding seems to work like magic. No other tool displays the charm of compounding like the Rule of 72. The formula works well when applied to savings or investments that earn compound interest, specifically, simple compound interest.
The equation involved in the Rule of 72 is straightforward. The sole input of the equation is the interest rate of the savings or investment in question. Divide the number 72 by the interest rate to yield the number of years it will take for your money to double.
All this talk of mathematics, formulae, and equations can make some people queasy, but the Rule of 72 is friendly enough for even the most maths-averse person to use. Say, for example, you open a savings account with $100 at an interest rate of 3%. It will take 24 years for your savings to grow to $200. With these figures handy, you can now make an informed decision about whether you ought to save more money or if you should shop around for a higher interest rate.
The Rule of 72 can also be used to determine how long it will take for an asset to depreciate. For example, suppose you have a foreign currency account, and you’d like to know how valuable the currency will be in the mid-term or the long term. Rather than using the interest rate in the formula, you would insert the inflation rate to find out how many years it takes for the currency to diminish in worth.
It’s crucial to bear in mind that the output of the Rule of 72 equation is simply an estimate. While immensely useful, it is only approximate arithmetic, not wholly accurate.
The Rule of 72 and Interest Rates
If you have a diversified portfolio, there might be different interest rates at play. Perhaps you’d like to see how well your portfolio is doing by comparing the myriad interest rates. The Rule of 72 can help with this as well.
Using the calculation can help you see at a glance if you ought to make any changes to your financial plan. Standard interest rates include 1%, 6%, and 12%. At these rates, any investment would take 72 years, 12 years, and six years, respectively, to double.
For short-term goals, a higher interest rate could be more favourable. Whereas for long-term goals, you might be satisfied with a more modest interest rate. Just be sure to avoid interest rates that will take 800 years to double your investment!
After assessing your financial status, should you find that you have the advantage of surplus savings, it would be wise to put that extra money to good use. Invest your wealth long-term via the stock market where you can get high returns, whether through a private pension plan, an individual savings account, a general investment account, or somewhere else. Placing a high value on your financial future through investing is empowering and encouraging.
Alternative Rules
Variations of the Rule of 72 exist, such as the Rules of 69.3 and 69.
The Rule of 72 is extremely helpful when the interest rate in question is low, that is, rates ranging from 6% to 10%. However, the higher the interest rate, the less accurate the output of the equation. Because of this, some experts use the Rule of 69.3, which is far more exact. Using 69.3 can also accommodate different kinds of compounding.
The Rule of 69 is handy because it can be adapted to any interest rate, be it high or low. If you’re curious about how long it will take to triple or quadruple your savings or investments, you can look up the rules of 114 and 144.
As mentioned above, the Rule of 72 is an estimate. 69.3 is a slightly more precise figure, but because it is not as convenient for calculations as 72 is, investors tend to use the latter number.
Anyone interested in wise financial planning needs the Rule of 72 in their arsenal. The best thing about such a rule is that it can show you, the value of an investment. A chief benefit is dispensing with the need for complicated spreadsheets and equations.
So, if you’ve secretly always been a stickler for rules, now’s your time to shine because rules are cool again.
