The Rule of 72 is a handy shortcut for estimating how long it will take for an investment to double in value when you know its annual rate of return. You can use it to quickly figure out doubling times in your head.
How does it work? Simply take the number 72 and divide it by the investment's expected annual rate of return. The result will be the approximate number of years it will take for that investment to double. It's called the Rule of 72 because 72 is the magic number that makes this math work out.
Here are some examples
If you have an investment that is earning an annual return of 12%, you divide 72 by 12 to get 6 years. That means at a 12% rate of return, that investment would double in around 6 years. What if the annual return is 8% instead? Just take 72 divided by 8, which equals 9 years. So at an 8% annual return, it would take approximately 9 years to double your money. The Rule of 72 works for any rate of return between 6% and 20%. Returns higher than 20% double money extremely quickly, so the Rule starts to lose accuracy. Returns lower than 6% take quite a long time to double so rounding to whole years gets difficult. But for that middle range which covers typical stock market and bond returns, the Rule of 72 gives you an easy shortcut to determine doubling times.
One great use of the Rule of 72 is comparing different investments. For example, say you are considering two mutual funds - Fund A which averages 10% annual returns and Fund B that averages 8%. Which one do you think will double faster? You can quickly apply the Rule of 72 to find out. For Fund A, divide 72 by 10 and you get 7.2 years. For Fund B, 72 divided by 8 equals 9 years. Therefore, at a 10% return rate Fund A would double about 7 years faster than Fund B at only 8%. This info helps you see that just a couple percentage points difference in annual return rate can have a big impact on how quickly investments can potentially double. The Rule of 72 makes these doubling time calculations quite simple. The Rule also works well for goals-based planning and investing. If you know you need a certain investment amount in 6 years, you can use the Rule of 72 to estimate what rate of return you would need to double your money in that timeframe. In this case, divide 72 by 6 which gives you an annual rate of return of 12%. So if you earned a 12% annual return, your investment would be on track to double in 6 years.
As you can see, while the Rule of 72 is only an approximation, it does provide quick insights into growth rates and doubling times that can help guide investment decision-making. Plus it only requires some simple mental math rather than complicated finance formulas. So for communicating key investing concepts to clients, demonstrating comparisons, or setting investment goals, the Rule of 72 is an easy-to-use tool that often gets the point across. So the next time you want to forecast growth or evaluate an investment's future value potential, keep the Rule of 72 in mind. Divide 72 by the annual return rate and you'll get a good ballpark estimate of how many years it will take to potentially double your money. No calculator required!