The Rule of 72

Posted by Maneesh Sethi :: August 3, 2007 @ 10:34 am

Want to know how much you can earn from investing? In a previous article, I talked about why you should invest early: compound interest will make you a lot of money, but only if you give it enough time to work its magic. Today, I’ll show you why.

The rule of 72 is a really quick and easy way to see how fast money can grow. The rule is as follows: divide 72 by the interest rate you expect to get (the average market returns from 1926-2000 was 10.70%). The result is approximately the number of years it takes for your money to double.

Say you give yourself a conservative estimate for your investment: 8%. 72/8 = 9, so it will take 9 years for your money to double. $1 today becomes $2 in 9 years, $4 in 18 years, $8 in 27 years, and so on.

This means that every 9 years you wait to invest, your future money is halved. Putting in $1,000 dollars today at 8% is worth $32,000 in 45 years, but if you wait until you are 9 years older, it’s only worth $16,000. A corollary is that if you decide to invest for 54 years instead of 45 years, your money will be worth twice as much.

Note: the rule of 72 is a quick method to estimate returns, but it's not perfect. It works best for reasonable values, but when the interest rate increases, the rule of 72 is not as accurate. For example, if you were making 72% returns on your investment in a year (and please tell me how you're doing it), the rule of 72 says you should double your money in 1 year, while in actuality it would take 1.28 years.

Use the following algorithm for a quick way to see how much money you could make:

1. Divide 72 by the interest rate. This is the number of years it takes to double your money.

2. Decide how many years you will invest for.

3. Divide the result from step 2 by the result from step 1. This is how many times your money will double.

4. Find the value of 2^(result from step 3). This is how much one dollar will be worth after you wait for the specified number of years. (Using exponents, 2^1 = 2, 2^5 = 32, 2^10 = 1024, etc.)

5. Multiply the number from 4 by however much you are investing. That is how much your investment will be worth.

Thus, if I invest $10,000 and I expect 9% interest, my calculation will be as follows:

1. 72/9 = 8

2. 48 years (until I’m 68 years old)

3. 48/8 = 6

4. 2^6 = 64

5. $10,000*64 = $640,000

My $10k became $640k. Not bad, eh?

As I stated before, the rule of 72 is only an estimate, so while the estimated answer above is $640k, the actual value is about $626k. You can see the differences between the actual time it takes to double and estimated time here.

Good luck!