The Rule of 72: A Simple yet Powerful Financial Tool to Estimate Investment Growth

Date Published: 16 March 2023

Understanding the Rule of 72

The Rule of 72 is a straightforward mathematical formula used to approximate the number of years required for an investment to double in value. The formula is as follows:

Years to Double = 72 / Annual Rate of Return

The annual rate of return is expressed as a percentage. For example, if an investment has an annual rate of return of 6%, it will take approximately 12 years (72 / 6 = 12) for the investment to double in value. This rule is based on the concept of compound interest, which assumes that interest earned on an investment is reinvested, leading to exponential growth over time.

Applications of the Rule of 72

1. Investment Planning: The Rule of 72 can help investors quickly assess the potential growth of their investments and compare different investment opportunities. By understanding how long it takes for an investment to double in value, investors can make more informed decisions on where to allocate their resources.
2. Retirement Planning: The Rule of 72 can provide a rough estimate of how long it will take for retirement savings to double, helping individuals plan for their financial future. By knowing the approximate time frame, investors can adjust their savings rate, investment strategies, or retirement goals accordingly.
3. Inflation Impact: The Rule of 72 can also be used to estimate how long it will take for the purchasing power of money to be reduced by half due to inflation. By dividing 72 by the annual inflation rate, individuals can better understand the impact of inflation on their financial goals and plan accordingly.

Limitations of the Rule of 72

While the Rule of 72 is a valuable financial tool, it is essential to recognize its limitations:

1. Accuracy: The Rule of 72 is an approximation and becomes less accurate as the annual rate of return increases or the compounding frequency changes. Investors may need to use more advanced mathematical formulas or financial calculators for more precise calculations.
2. Fixed Rate of Return: The Rule of 72 assumes a fixed annual rate of return, which may not be accurate for some investments. The actual performance of an investment may fluctuate over time, affecting the time it takes for the investment to double in value.
3. Simple vs. Compound Interest: The Rule of 72 is based on the concept of compound interest, and its accuracy diminishes when applied to investments that earn simple interest.

Using the Rule of 72 Effectively

Despite its limitations, the Rule of 72 remains valuable for investors. To use the rule effectively, consider the following tips:

1. Use as a Guideline: Treat the Rule of 72 as a rough estimate rather than a precise calculation. It can provide a helpful guideline for investment planning but should not be the sole basis for financial decisions.
2. Diversification: Diversify your investment portfolio to account for fluctuations in the performance of individual investments. This strategy can help mitigate the impact of variable rates of return and market volatility.
3. Monitor Performance: Regularly review your investments and their performance to ensure they align with your financial goals. Adjust your investment strategy as needed based on changing market conditions, personal circumstances, or risk tolerance.

More examples

So, let’s say you have $10,000 in your Savings Account and it pays you 10% return after tax per year (spoiler: they don’t… not by a long shot).  How long would it take for your $10,000 to double based on interest alone?

Well, if you withdraw the interest every year, at 10% return, it will take 10 years (obviously).  But through the magic of compound interest, it will take a lot less time.  How much less?  Well, about 2.8 years meaning it takes about 7.2 years to double.

And it turns out that is the magic (approximate) number.

72 divided by the annual return gives you the approximate number of years it will take to double.

As another example, a return of 9% would take roughly 8 years to double (72 divided by 9 = 8 years).

It’s not exact and is just meant as an estimate.  For instance, the true time for a 9% return is 8.04 years but for a quick, back-of-the-napkin calculation 8 years is close enough.

It also gets a little more inaccurate as you approach the extremes.  For instance, an investment with 100% return, takes exactly a year to double, not 0.72 of a year.  But as a very quick, easy formula in most cases, the rule of 72 is great to use.

The Rule of 72 and property

Obviously, this formula isn’t just for savings accounts.  Let’s say property in your local area has a long term capital growth rate of 5%.  How long would you estimate it will take for your property to double in value (barring some unforeseen market hiccup)?  72 divided by 5 is 14.4 years, so you could expect your property to double in 14 or 15 years time (all things being equal).

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