What is the ‘Rule Of 72’
The rule of 72 is a shortcut to estimate the number of years required to double your money at a given annual rate of return. The rule states that you divide the rate, expressed as a percentage, into 72:
Years required to double investment = 72 ÷ compound annual interest rate
Note that a compound annual return of 8% is plugged into this equation as 8, not 0.08, giving a result of 9 years.
Based on our conversation earlier about compounding and how it is your friend. We are going to discuss how the rule of 72 can help you.
So how long does it take to double your money? You can likely double it in 10 years if you invest in stocks or 72 years if you put it into a savings account.
Everyone says you should invest your money because that is where you have a much better chance to grow your money.
Stocks are one of many possible ways to invest your money. While the future is never guaranteed, history suggests that they have high potential returns. The long-term average return of the Standard and Poor’s 500 Index is about 10% per year from 1928 to 2014. Warren Buffett several years ago, in the aftermath of the financial crisis, said that investors should expect a return of 6% to 7% a year.
Please keep in mind that these are long-term averages and the market could go down in a given year. Which would mean you would need to keep the money invested for several more years to recover. This is why it is best to work with money you are not likely to need in the next few years.
According to experts today’s average savings account rate is 0.09% and with inflation increasing at about 2% a year that means if you put your savings solely into a savings account you are actually losing money!
So to use some examples to illustrate the points being made:
Savings account interest rate = .05% Investment interest rate = 4%
Amount saved = $10000 Amount Invested = $10000
Years to double your money = 1440!!! Years to double your money = 18
Just by doing some simple math you can see for yourself that simply stuffing your money into a savings account is not going to get you where you want to go. Are savings account safe? You bet. Are they insured if something happens? Also correct. Can they lose money? Very unlikely, unless in case of negative interest rates which would cause you to have to pay to keep your money in a savings account.
This rule could also be used in reverse. Let’s say you wanted to figure out how much interest you would need to earn to double your money in a set number of years. This would help you get a better understanding of whether or not your expectations where realistic or not.
So let’s say you wanted to double your money in 4 years. What interest rate would you need to earn to achieve this?
72 divided by 4 equals 18%
This is the compounded rate they would have to earn to achieve this goal. Not let’s say you want to double your money in 12 years. What would be the rate you would need to achieve this goal?
72 divided by 12 equals 6%
So you would be able to double your money in 12 years with a 6% annually compounded rate.
The Rule of 72 was invented by our old friend Albert Einstein.
Let’s take a closer look at how this rule can help you with investing and growing your money thru your life. If you are 24 years old and you have $5000 in savings and you put it into an investment that earns 8%. According to the rule of 72, it will take nine years to double your money. So at 33 you now have $10000 and at 42 you would have $20000. If you keep it going at 51 you would have $40000 and at 60 you would have $80000.
So you would have grown your money from $3000 to $80000 without adding a single cent! Your money has been working for you and all you had to do was nothing! This is the power of compounding and the stock market.
In conclusion, I hope you have learned how the amazing rule of 72 can be such a powerful tool to help you decide how to have your money work for you. And that not all math is bad or hard. With the power of compounding and time you are bound to achieve the wealth you are looking for.
We will continue to look at ways to help have your money work for you and how it can do some of the heavy lifting for you.
As always thanks for checking out my thoughts here and please let me know if you have any questions and comments.
Until next time, take care.