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Investing can be active or passive, but the beauty of even the most passive investment strategy is that money, well invested, will continue to grow through every investor’s best friend, compound interest.
Even investors who only fund an investment once could see doubling.
There are tons of calculators out there that will tell you how long it will take you to double your money, but if you are looking for a quick version, you just need the Rule of 72.
The Rule of 72 is an easy way for investors to approximate how long their investment will take to double, given a fixed rate of return.
This simple calculation can be done on a cocktail napkin in a bar or on the back of a receipt standing in line for a burrito.
What Is the Rule of 72?
The Rule of 72 is a quick and easy way for investors to estimate how long their investments will take to double, given a fixed rate of return annually.
As we all know, interest rates aren’t fixed, and they fluctuate from year to year, so the Rule of 72 is intended to give investors a ballpark than a finite answer.
The Rule of 72 can be useful in making projections for retirement, education, or other long-term goals but will not be useful for short-term goals.
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Understanding The Rule of 72
The Rule of 72 is based on the idea that compound interest helps to grow investment. Compound interest is what helps us add money to our investments even if we do not continually fund them or make any major money moves.
Imagine a snowball rolling down a hill. The bigger the snowball gets, the more snow it collects as it rolls. Make that snowball your investment, and compound interest is all that extra snow it picks up as it rolls.
The Rule of 72 is a quick way to tell investors how long it will be before that snowball doubles in size.
How Does the Rule of 72 Work?
The Rule of 72 simplifies a calculation that, most certainly, cannot be done on the back of a cocktail napkin.
To find the actual, precise calculation for how long your money would need to double based on the Time Value of Money- you would need a calculator with logarithmic function or Rain Man’s brain.
Here is the original formula:
Time = ln (2)/ln(1 + r/100)
- T= Time to Double
- ln= Natural Log Function
- R= Rate
72 is derived from natural log of 2. The natural log of 2 is .693 or 69.3%, but 72 is divisible by 1, 2, 4, 6, 8, and 9 easily, and the Rule of 72 is for everybody.
To find the number of years it will take your investment to double, you only have to know a projected interest rate. Divide 72 by the rate of return, and you’ve got your number of years.
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Rule of 72 Formula
Years to Double Investment = 72 / Compound Annual Interest Rate
Rule of 72 Example
Bobby just made his earth-side debut, and the grandmas have given you $50,000 to invest for Little Bobby’s college.
Knowing that Where You Live State or WYLS costs $200,000 for a 4-year degree, you can use the Rule of 72 to determine whether you should be adding extra funds or if the $50,000 today will be enough to pay for Little Bobby’s college in 18 years. Assuming an 8% rate of return, will you have enough?
72/8= 9 years for one double. $50,000 + $50,000 = $100,000 and additional 9 years (for a total of 18) would mean $100,000 + $100,000 for a grand total of $200,000 in 18 years.
Why Is the Rule of 72 Important for Investors to Know?
The Rule of 72 is a quick and easy way for investors to estimate how long they will need to double their money given a fixed rate of return.
Even though we know interest rates fluctuate from year to year, it is still an excellent jumping-off point for investors to know if their investment goals will meet their timeframe.
Investors who require their money sooner than the projected number of years might need to select a more aggressive investment. Those who have a bit longer could reel back on the risk associated with the investments of their choice.
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Who Invented the Rule of 72?
The first reference to the Rule of 72 came from the Summa de Arithmetic of Luca Pacioli from 1494. Luca Pacioli was granted the nickname “Father of Accounting” thanks to the revolutionary knowledge he discusses in this book Summa de Arithmetic.
However, he only mentions the Rule of 72 in Summa de Arithmetic but does not explain it or show the math that derives the rule, so it is assumed that the Rule of 72 predated him, and he was just the first person to write about it.
Who Should Use the Rule of 72?
The Rule of 72 is perfect for anyone looking to do a super quick calculation to estimate how long it will take their investment to double.
While the Rule of 72 is not precise, it’s a tool that can help investors predict whether or not they are on target with their goals.
When Should Investors Use the Rule of 72?
While the Rule of 72 is certainly not precise, it can help investors know whether their investments will help them meet their goals, their risk vs. reward projections, and if they should be increasing the amount of money they are investing, just to name a few.
Bottom Line: What Is the Rule of 72?
The Rule of 72 is an expedient way for investors to approximate how long their investment will take to double.