You may have heard of the famous Rule of 72 – know how to double your money. They say, if you understand this rule, you’ll be able to master your own investments.
People in finance love talking about numbers and frequently refer to such terms as past performance, expected returns, fixed interest, compounding interest and so on. But these terms often mean little to an individual investor.
There are even spruikers in the investment world that love to talk about how some investments could double in “10” years and how they may double again over the next 10 years. All this can become very daunting and confusing until you master the “Rule of 72”.
Understanding the Rule of 72 allows you to make fast calculations on how long it may take you to double your money. Nonsense you may say, well let me explain how this may be possible.
So, what is the Rule of 72?
The "Rule of 72" is a simplified way of determining how long an investment may take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it may take for the initial investment to double.
By understanding the Rule of 72 you can quickly determine:
- The rate of return required for an investment to double in value over a pre-defined number of years.
- If you know the rate of return on your investment, you can quickly determine how long it will take for your investments to double in value.
When dealing with low rates of return, the Rule of 72 is fairly accurate. The chart below compares the numbers given by the Rule of 72 and the actual number of years it takes an investment to double.
Let’s put the Rule of 72 to the test
The following are examples on how the Rule of 72 works.
Example 1 - What rate of return do I require for my investment to double in 10 years?
What to do?
Divide 72 by the number of years. For example it is 72/10 = 7.2 You will therefore need a return of 7.2% each year.
Example 2 – I want my investment to double in 6 years. What rate of return do I need?
Again, divide 72 by 6 = 12 You will therefore need 12% each year.
Example 3 – The real estate salesman told me that house prices in my location have doubled over the last 15 years. What has been the return on investment?
Again, divide 72 by 15 = 4.8%
Example 4 – I’m earning 4% on my bank deposit, how long will it take for my investment to double in value?
In this example, you will need to divide 72 by the interest rate. 72/4 = 18 years. As you can see, the rule is very simple However, there are some factors that you need to take into consideration:
- The rate of return using the rule of 72 is the net return (after taxes and fees);
- The results are based on yearly compounding returns. This means the investment return is added to the initial investment each year; and
- The “Rule of 72” provides you with a general average, and it is important to consider market conditions which may produce a more or less favourable result.
From the examples mentioned above, and as you practice, you will learn to conduct these calculations in your head, or simply use the calculator on your mobile phone. That never leaves home without you.
You may even wish to impress your guests at a dinner party when the topic of investment comes up.
Happy investing.
