What is the ‘Rule of 72’ and How Does it Work?
When it comes to investing, it’s often difficult to know if you’re getting the best bang for your buck. Should you be putting more money into mutual funds or ETFs? What about tech stocks? Is there any value in precious metals? What’s all this buzz about Bitcoin and cryptocurrency? Even if your money is earning a slow and steady return, there’s always that desire to “get rich quick.” If you just got lucky on a penny stock or scored big on an initial public offering (IPO), you retirement could come a lot sooner.
Experiences investors already know the truth, though. It’s just not that easy. There is no foolproof way to double your money, except to let it grow over time. That’s where the Rule of 72 comes into play. It’s a simple calculation that tells you roughly how long it will take for your money to double. It’s based on the interest rates your savings are earning for you. While those rates may vary over the years, the calculation is a pretty easy one.
Rule of 72
The formula is: 72/interest rate = how many years to double your money. Here are some examples using round numbers as interest rates.
If you earn 1%, it takes 72 years for your money to double. (72 divided by 1).
If you earn 2%, it takes 36 years for your money to double. (72 divided by 2).
If you earn 3%, it takes 24 years for your money to double. (72 divided by 3).
If you earn 5%, it takes 14.4 years for your money to double. (72 divided by 5).
If you earn 8%, it takes 9 years for your money to double. (72 divided by 8).
Most interest rates aren’t that tidy, of course. Many of us might see 1.69% interest on a savings account or a 4.37% return on mutual fund investments for a specific year. Still, the Rule of 72 is a nice way to quickly gauge how much money you’ll have at retirement age.
It’s important to remember that the Rule of 72 doesn’t take any further contributions into considering. If you continue to put money away into savings and investments, they will obviously double in value much quicker than if you just let the interest do the work.
Don’t Get Too Excited — Or Too Disappointed
Many of us saw great returns on our investments in 2019, as rate of returns for many managed investment accounts hovered around 10%. Using the Rule of 72, that means that money will double in just 7.2 years. High fives all around, right?
Not so fast.
Traditionally, high rates of return like that don’t last. The first part of 2020 has already seen the stock markets take a huge hit thanks to the economic impact of the Coronavirus scare. It’s unlikely that 2020 will rebound enough to give anyone a double-digit rate of return. By the end of the year, your Rule of 72 calculation might look a lot less exciting.
Be Smart With Your Money
Knowing the Rule of 72 should help remind you some basic financial advice. First, even a slightly higher interest rate will pay off over the long term. If you are trying to choose between a savings account that offers 1.5% annual percentage yield (APY) and one that offers 2.25% APY, well… it should be an easy choice. The first one will double your money in 48 years. The second one will only take 32 years.
The other obvious conclusion from the Rule of 72 is that you should always be trying to put your money in the spot that offers the highest return. The higher the growth percentage, the quicker your money will double. (Plus it will grow even faster if you consistently add to your savings, which everyone should do.)
Be careful about chasing high interest returns. The investments that offer the highest potential returns are usually the ones that also have the highest amount of risks. Sure, you could score a 12-to-15% return in a short period of time. Or your money could disappear forever.
Then again, leaving your money in a savings account at 1.25% isn’t exactly smart either. Yes, it’s safe there, but it’s barely growing. Most financial experts would warn you that it’s a little too safe.
As always, the best thing to do is diversify your investments. Put a percentage of your savings into safer, more reliable vehicles. Sure, they may take longer to double, but at least they won’t vanish. Then pour some of your money into high-risk, high-reward scenarios. If they win big, you’ll double your money quicker than the safe investments. But if they lose, at least you won’t have to start from scratch.