What is the Rule of 72?
Definition: The rule of 72 is a mathematical means to gauge the amount of years it takes for the money to double compounding interest. To put it differently, it’s a simplified strategy to determine how long that your money needs to be spent as a way to double at a given interest rate.
What is the Rule of 72 Used For?
Investors frequently use this calculation when assessing the gap between comparable investments. They would like to see their investments grow so that they could take the profits to invest in greater chances later on. Remember this doesn’t have to be Wall Street investors or brokers.
Average Americans can use this method to estimate the amount of money they will have in a retirement account or how many their share in a mutual fund will be worth in five years. The decree 72 will calculate how long it takes to double your money in an investment. In other words, it’s a simplified, very limited future value calculator that will compute the value of your investment in the future.
This formula is a great shortcut because the full-length investment equation for compounding interest is long and complicated. You can use this simple decree of thumb as a base estimate for investments. Here’s how it works.
The decree of 72 formula is calculated by multiplying the investment interest rate by the number of years invested with the product always equal to 72.
Applying a little bit of algebra we can rearrange the decree of 72 equation to calculate the number of years required to double your money with a given interest rate compounded annually.
Or it is written like this to calculate the annual compounded interest rate required to double your investment in a given time period.
Keep in mind that the decree of 72 definition requires that the interest be compounded annually. This method will not work for investments with semi-annual or quarterly compounded interest as is. If you want to use this method for investment returns like that, you will need to modify it.
Let’s take a look at an example.
Here’s an example table of the way a decree of 72 calculator works. As you can see, the before all else column represents the annual rate of investment that will be compounded at the end of every year. The second column shows the number of years it will take for the investment to double in value. The third column is always 72 because that’s how the formula works. The investment rate multiplied by the number years is always equal to seventy-two.
Let’s assume you have $10,000 to invest in a mutual fund and you want to know how long it will take to become $20,000. You are positive that you can obtain an average return of 8 percent each year. Looking at our table above, we can see that it will take your investment about 9 years to reach the $20,000 goal.
We can also do the reverse calculation. Let’s assume you have $10,000 and you want to know what annually compounded interest rate you will need to double your money in 5 years. Going back to our table, you can see it will require an interest rate of a little over 14 percent to meet your $20,000 goal in a 5-year span.
How is the Rule of 72 Used?
Obviously, we could have used the equation to calculate each of these examples, but I figured the table would be easier. We can also use a future value calculator or the actual future value formula to verify that these numbers are accurate, but we don’t need to. This procedure works. It’s a fantastic shortcut since it enables you to readily gauge the worth of your investment to the future with no technical particulars of the true future value equation. Based on the rate of interest, you can most likely do the calculations in mind.
One factor to remember is that this technique doesn’t take into consideration additional potential things that can hamper your investment aims. For example, inflation levels may vary over the span of your investment’s lifetime span. You may however apply the decree of 72 to figure out the consequences of inflation on your money. By way of instance, if the inflation rate moved from 3% to 4%, your funds will eliminate half its worth in 18 decades rather than 24 decades.
You may also compare the growth of present prices like tuition and healthcare expenses together with the interest rate. That is pretty can. Test it out yourself. It’s possible to use it to get all sorts of enjoyable future value calculations.