What’s the Rule?
If you have never heard of the Rule of 72, rest assured because you will after reading this article! If you are already familiar with the rule, great! You’re on the right path!
The Rule of 72 is basically a shortcut to estimate the number of years required for you to double your finances at a given annual rate of return.
How Does it Work?
The rule states that you divide the rate (as a percentage), into 72: Years required to double the investments =72 ÷ compound annual interest rate.
Of course I understand that giving you a simple equation won’t completely break down how the rule works and why it’s so important, so I’ll give you an example.
See For Yourself
So let’s say you are an investor…and you decide that you would like to invest a small amount of $1000 at an interest rate of 4% per year. The Rule of 72 will double your money in about 18 years.
72 / [periodic interest rate] = [number of years to double principle]
72 / 4 = 18
Now, using the same rule of 72, if you invest the same amount of $1000 at an annual inflation rate of 2%, you would lose half of your principle in 36 years.
72 / 2 = 36
The Rule of 72 can also be used to demonstrate the long term effects of period fees on an investment such as mutual funds, life insurance, and private equity funds.
Why it Matters
Although this calculation is relatively simple with a calculator or spreadsheet, this method was derived before the 14th century, and is still today a quick and relevant calculation for the effects of compound interest.
Be that as it may, it is still important to know that the Rule of 72 is an approximation, and not exact. This rule is accompanied by the Rules of 70 and 69, which are used the same way, but are more accurate for smaller periodic interest rates.