Rule Of 72: What Is It And How Does It Work?

The Rule of 72 is a simple formula that can help investors determine how long it will take for a particular investment to double in value. The Rule of 72 has become a bit obsolete given how common calculators and programs like Excel are nowadays, but it can remain useful as a rule of thumb that you can easily calculate in your head. Using the Rule of 72 can help you compare different investments to see how they might perform over time. We will take a look at the Rule of 72 formula to determine how you can help make it work for you.

What Is The Rule Of 72?

The definition of the Rule of 72 is a way to determine how many years are necessary to double the amount of money that you have invested at a particular annual rate of return. This can be a useful tool in many areas of personal finance. While the Rule of 72 will not give you an exact answer, it is usually close enough to serve as a reasonable approximation. Using the Rule of 72 to approximate how long it will take for a particular investment to double will help you decide whether it is worth pursuing the investment further and doing more precise calculations.

Rule Of 72 Formula

The Rule of 72 formula takes two inputs — the number of years for an investment to double and the annual rate of return of that investment. Given one of those two values, you can use the Rule of 72 formula to calculate the other by dividing 72 by the initial value.

• Number of years for an investment to double = 72 / annual rate of return
• Annual rate of return = 72 / number of years for the investment to double

How The Rule Of 72 Works

The Rule of 72 is great if you’re looking at an investment with a given rate of return and trying to get a rough idea of how many years it will be until that investment doubles. It's important to realize when using the Rule of 72 that it only works for investments with compound interest. If your investment earns money using simple interest, the Rule of 72 will not work for you.

Rule Of 72 Example

Here are a few Rule of 72 examples to give you an idea of how you can use the Rule of 72 when determining how long it will take an investment to double:

• To determine the amount of time it will take an investment earning 4% per year to double — 72 / 4 = 18 years.
• To determine the amount of time it will take an investment earning 8% per year to double — 72 / 8 = 9 years.
• To determine what rate of return you need to earn for your investments to double in 3 years — 72 / 3 = 24% annual rate of return or interest rate.
• To determine what rate of return you need to earn for your investments to double in 12 years — 72 / 12 = 6% annual rate of return or interest rate.

The number of years for a particular investment to double and the annual rate of return of the investment are inversely correlated. That means as one goes up, the other goes down. The higher your annual rate of return, the fewer years it will take for the investment to double in value. Similarly, the lower the annual rate of return of a specific investment, the more years it will take for that particular investment to double in value.

How Accurate Is The Rule of 72

As we've discussed earlier, the Rule of 72 is mostly useful as a simple approximation. While the Rule of 72 is surprisingly accurate for rates of return between 6% — 10%, it becomes less accurate for rates of return much lower or much higher. Also, the Rule of 72 works best for annual compounding. If you have other types of compounding (like daily or continuous compounding), you can also use the Rule of 69.3 or the Rule of 70 in similar fashions. The Rule of 72 is a useful approximation because 72 has so many small divisors (3, 4, 6, 8, 9, 12) — that makes it easy to do the calculations in your head.

Using The Rule Of 72 For Investments

There are many different applications for the Rule of 72, since it can be used on investments in many different sectors. Real estate investors use the Rule of 72 to compare investment options, and others use the Rule of 72 when planning for retirement.

It's important to understand that the Rule of 72 only gives an approximation of how many years it will take for a given investment to double. You'll want to make sure to do a more exact calculation before putting any of your money into a given investment.

The Bottom Line

The general idea behind the Rule of 72 is a simple formula using the annual rate of return of an investment to get an approximation for how long it will take the money invested to double. To use the Rule of 72 when calculating the amount of time required to double an investment, simply divide 72 by the annualized rate of return of the investment. The Rule of 72 will only give you an approximation, so make sure to run more detailed calculations before proceeding any further.

You might also talk with a financial adviser before making a decision about future investments.

Want some extra help staying on top of your expenses? You can easily create and track your budget using Rocket Money, now available on mobile app or web. Rocket Money will even scan your expenses for you and negotiate bills to help you save.