What Is the Rule of 72?

Table of Contents:

1. How the 72 rule works
2. The 72 rule formula
3. How to apply the rule of 72 to your investments
4. Rule of 72 examples
5. Investment planning with the 72 rule
6. The bottom line

As you learn how to invest in stocks and, hopefully, begin to see your money grow in your investment accounts. It can be a pretty exciting time, and you may want to get an idea of what the future could look like. Although we never know what the stock market will do, one step in planning and setting goals for our financial future is figuring out the projected growth of our investments. That’s where the rule of 72 comes into play.

What’s the 72 rule? It’s an easy way to estimate how long it will take investments to double through compound interest at a fixed annual rate. This can be done by dividing 72 by the annual rate of return.

Key Takeaways:

• The rule of 72 is a simple formula that, along with the rate of return, can be used to calculate the time it will take to see your investments double. The simplicity makes it especially perfect for those investing as a beginner. It’s important to remember, however, that the stock market is unpredictable.
• The rule works with compound interest but is just an approximation when interest rates fall between 6% and 10%.
• The 72 rule can also be used to calculate how inflation and annual fees can affect the value of your money.
• When calculating growth, the 72 rule doesn’t take fees and taxes into account.

How the 72 rule works

One thing to note is that the 72 rule works with compound interest, not simple interest. With simple interest, interest is only earned on the principal amount invested, whereas compound interest is when interest is earned on the interest plus the principal amount.

Compound interest allows investments to increase more aggressively, and as it does, so does the rate of growth. An example is when you reinvest dividends earned on investments. Those earnings are compounded, so the rule of 72 would be relevant.

Rule of 72 chart

So, when would you need to use the rule of 72?

Since the rule of 72 is used to estimate how long it takes to double your money using a particular interest rate, it can be used in situations where there is exponential growth, such as with compounding interest as well as in cases of exponential decay, which is when purchasing power is reduced, such as in times of inflation.

Common uses for the rule of 72 include:

• Investing accounts – When saving for retirement, the rule of 72 can help determine how fast you may be able to double your investments over a certain time period by plugging in your interest rate.
• Savings account – By dividing 72 by your interest rate, you can determine how long it may take to double it.
• Inflation rates – Although inflation rates affect the economy as a whole, they also can determine the value of your money and how long it could take to lose that value.

Variations to the rule of 72

Other variations of the 72 rule you’ll want to become familiar with include the 73 rule, among others. If you’ve never heard of them, you may be wondering what they are, why they’re important, and how to figure out what number to use.

While the rule of 72 is mainly used with interest rates falling between 6% and 10%, not all rates fall between those ranges, which is where the rule of 73 can become helpful.

In general, the 72 can be adjusted by 1 for every 3 point deviation in any rate changes. As an example, if you have a rate of 5%, the rule of 71 would be used, and if the rate was 11%, you’d use the rule of 73. If the rate hiked to 14%, the rule of 74 could be implemented.

When using the rule of 72 formula, there are a few things to keep in mind:

• When plugging in the interest rate, it should be expressed as a number, not a decimal. For instance, instead of using 0.08 for 8%, you’d just use the number 8.
• The 72 rule is focused on compound interest.
• To get an even closer result, use 69.3 instead of 72, although doing the math can be more challenging without a calculator.
• The further you divert from 8% in either direction, the less accurate the rule of 72 is, so using variants can be useful.

The 72 rule formula

Using the rule of 72, the formula below shows what calculating investment doubling time can look like. If R x T = 72, with R as the rate of growth of the annual interest rate and T as the time (in years) it takes for the money to double in value. It looks like this using a 6% interest rate:

R x T = 72 R x T = 72

R = 6% T = 72/6

6T = 72 T = 12 (years)

How to apply the rule of 72 to your investments

You might be thinking: “okay, so how do I apply the rule of 72 to my investments?” Here’s where to start.

Step 1: Determine your investment goals

The rule of 72 helps you determine if you’re on track to hit your investment goals, but the formula won’t do you much good without actually knowing what your investment goals are.

Start by determining, or reminding yourself of, your end goal. Maybe you want to retire at age 55 with $1,000,000 in the bank, or perhaps you’re aiming to save $800,000 by age 65. Having a firm grasp on your goal and timeframe for achieving it will make applying the rule more effective.

Step 2: Get an accurate “R” estimate

The accuracy of the rule of 72 formula relies largely on the accuracy of the “R” value or the estimated rate of growth. Refer to the historical performance of your investments to determine a realistic rate of growth to plug into the formula.

As previously stated, the rule of 72 provides the most accurate estimate for interest rates that fall between 6% and 10%.

Step 3: Do some basic algebra

Once you have a realistic “R” value, plug it into the formula and solve for “T.” This will leave you with an estimate of how long it will take your money to double at its current rate.

Step 4: Compare the results to your goals

Take the example above and consider that your investments are growing at a rate of 6% per year on average. According to the rule of 72, your money will double in about 12 years. Great, done, right?! Not quite.

Now that you’ve estimated that your money is doubling every 12 years, does that put you on track to meet your goals? Refer back to the goals you determined in step one and compare where you are to where you want to be. If you find that you’re off track, it may be helpful to talk to an investment professional about your options.

Rule of 72 examples

When evaluating your investments, you may wonder if using the 72 rule will provide accurate information. As a rule of thumb, it’s considered to give pretty close results but not perfect. So, if your goal is to million, you may want to implement additional tools.

Suppose you’re looking for more definite results. In that case, you’d want to use a natural logarithmic equation, which is a mathematical formula that determines how many times a certain number, called the base, is multiplied by itself to reach another number.

You can think of it in terms of how many times you’d need to fold a piece of paper to get 64 layers. Every time you fold the paper in half, the number of layers will double, so the formula would be 2 (the base) x 32 = 64.

Investment planning with the 72 rule

For many people, the goal of investing is continuous compounding for the long term. Using the 72 rule, you can project your growth rate. You will also learn how long it will take to reach a specific amount of money if you know the average rate of return and your current account balance.

So, let’s say you have $100,000 invested at 10% interest, and you’re scheduled to retire in 22 years. In that time, you could see your money double about 3 times, going from $100,000 to $200,000, and then to $400,000 and finally hitting $800,000.

Considerations such as interest rates and other factors beyond your control may change plans, but the rule of 72 can help determine the strategies needed to keep you on track.

The bottom line

When learning how stocks work, you may want a quick and simple way to project the growth of your investments, and the 72 rule is a valuable tool. But like any strategy, it may not be the right approach for you to reach your investment goals.

This can be due to the fact that information needed to use the formula may not be constant and, therefore, may offer inaccurate results. Consequently, it’s always best to do your research and get financial advice from a professional when necessary.

Investing doesn’t have to be complicated. To learn more and begin your investment journey download the Public app today!