How to Use the Rule of 72 to double my money
How long does it take to improve your financial outlook and reach your financial goals?
For instance, how much would it take to double my assets?
THE RULE OF 72
The “Rule of 72” states that the amount of time required to double my money can be estimated by dividing the number 72 by the annual rate of return of my investments.
T = 72/r
Note: (T) is the time required, and (r) is the annual interest rate.
The Rule of 72 is a Golden formula in Personal Finance: it is a simple but powerful rule of thumb to design and manage our own portfolio of investments and set up realistic assumptions for our financial goals. Derived before the 14th century, it is still a quick, mental calculation compared to more complex logarithmic equations related to compound interest.
Let’s look at some examples with different investments:
- If I hold $500,000 in a saving account with a 1% annual rate of return, it will take 72 years to double my money (i.e. 72/1= 72 years)
- If I hold $500,000 in an investment product with a 7% annual rate of return, it will take 10.3 years to double my money (i.e. 72/7 = 10.29 years).
Let’s now look at the 7% annual interest case over 30 years:
Based on this rule, we can go back and improve our financial plan, designing the most suitable portfolio of investments that match our investment’s interest rate and time horizon.
- If I hold $100,00 in an investment product with a 7% annual rate of return, the amount will double to $200,000 after 10 years, reach 400,000 after 20 years and $800,000 after 30 years.
It is time to practice this financial workout using different scenarios (different interest rates and investment principal) and find your “sweet spot”. There are indeed many investments that have historically provided an annual rate of returns from 1% up to 12 % (stock market, bond market, real estate, P2P and crowd-funding).
What would be your ideal annual rate of return? How long will it take for you to double your investments?
- The Rule of 72 is reasonably accurate for interest rates between 6 and 10. When dealing with rates outside this range, the rule can be adjusted by adding or subtracting 1 from 72 for every 3 points the interest rate diverges from the 8% threshold. For example, the 11% annual compounding interest rate is 3 percentage points higher than 8%.
- The Rule assumes that any earning is annually re-invested (i.e. the interest is annually compounded).
- All these examples only consider a fixed principal: the possibility of further monthly/annual funds to top up the principal is not considered.
- The formula also works backwards: if you want to double your money in 6 years, the formula is the following r=72/T –> r=72/6 –> r= 12 (you need an annualised interest rate of 12 % to double your money in 6 years.
- To further elaborate on the projections, you can use this online calculator (link).