What Is the Rule of 72 and How to Use It When Investing?

The Rule of 72 is one of the most powerful tools in finance; it's a way to calculate how long it takes for an investment to double, given a fixed interest rate. Understanding and using the Rule of 72 will help you make better financial decisions and help you get a feeling of when you should start worrying if an investment isn't performing as expected.

Rule of 72: What Is it?

If you invest at a particular rate of return for a specified period, the Rule of 72 calculates how many years it will take to get double the cash you invested. Divide 72 by the fixed annual interest rate to find the number of years it would take for your investment to double. Assuming, for instance, you have a 4% annual return, it will take you 18 years to double your investment.

You can also use the same computation to determine inflation. It indicates the number of years until the value of the initial amount has been reduced by half, not doubling as in the previous example.

This approximation, known as the Rule of 72, is built from a complex computation, and as such, it is not precise. The most exact findings from the Rule of 72 are obtained when interest/return rates are at or around 8 percent, and the further away from 8% you go with either scenario, the less accurate the results. Nonetheless, this useful method can assist you in gaining a better understanding of how much the investment may increase if you assume a given rate of return.

Note that the fixed rate of return is on an investment that is on compound interest - that is, interest earned in one period is rolled back into the investment earning interest in the next period and so on. 

How to Calculate Rule 72: The Formula

The Years to Double = 72/Interest Rate

The interest rate here is the rate of return on an investment

Consider the following scenario: If an investment program guarantees an annual compounded rate of return of 8 percent, it takes roughly nine years (72 / 8 = nine years) to double the amount of money first deposited. It is worth noting that a compound yearly return of 8% is put into this calculation as 8, not 0.08, resulting in 9 years for the investment (and not 900).

Check out the table below for more examples. Note that the column ‘No. of yeats shows the actual number of years it will take illustrating the fact the rule of 72 is not very exact beyond 8% rate of return. 

Rule of 72 Reversed

You may also apply the Rule of 72 in reverse. For example, say you would like to calculate the interest rate you would need to double your investment in a specific number of years, for example, right before your first born child begins college. All you have to do is divide 72 by the number of years you would want your initial amount to have doubled. Check out the table below for examples:

How to Use the Rule of 72 

You can use the Rule of 72 when coming up with your financial goals and even looking at economic trends. Check out the uses of Rule of 72 below.

Credit Card Payments

The Rule of 72 can help you determine the amount you will finally owe the credit card lender. You do this by dividing 72 by the lender's interest rate. That allows you to see the length of time it would take to double what you already owe minus additional purchases.

Investments

If you are planning to invest, Rule of 72 helps calculate the period it may take for you to see a 100% return on your investment. Irrespective of your type of investment, rule of 72 will work for you as long as compound interest is applied. Only key in the interest rate for your investments.

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Inflation Rate

Inflation rates usually have an impact on the general economy. But you could escape from the trouble with the Rule of 72. You can discover how soon inflation rates may impact your finances. You have to run the Rule of 72 formula based on the annual or projected annual inflation rate.

Savings

Using the Rule of 72 calculation, you can project when your savings could double. What you need to do is divide 72 by your savings interest rates. The result is the number of years it takes to have double what you have.

Limitations of the Rule of 72

Rule of 72 does not offer a one-size-fits-all solution. It falls short under certain circumstances. Its limitations include:

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• Only applicable to compound interest. You cannot apply the Rule of 72 to simple interest because you can only calculate simple interest.
• Accuracy issues. You can only get an accurate estimation when calculating an interest rate of 8% and a fair estimate when calculating interest rates between 6 and 10 percent. Rule of 72 won't accurately calculate rates lower than 6 percent and above 10 percent.
• Annual Compounding. The Rule of 72 only works for investments that calculate compound interest yearly. If your loans or interests charge on a different schedule, you'll want to modify the Rule using the 69 or 70 rule rather than 72.

What About the Rule of 69.3?

As discussed earlier, the Rule of 72 is not quite accurate when dealing with interests outside 6 to 10 percent. But you don't have to be limited if your interest rates are higher or lower. Therefore, if you want a more accurate estimation, you want to use the Rule of 69.3.

Should You Use the Rule of 72?

You will agree that doubling your investment capital is not a walk in the park. However, it's thrilling when you can pinpoint the year in which your money should double. That's precisely what the Rule of 72 does. Therefore you should consider to use the Rule of 72 to analyze your investment goals, at the very least to get a picture of how significant potential returns look like.

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The Rule of 72 is a handy tool that can help you make informed decisions about your short-term and long-term savings. It is a helpful gauge that tells you how long it will take for your investment to double at any given interest rate.

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