Rule of 72

The Rule of 72 is a simple formula used to estimate how long it will take for an investment to double in value based on a fixed annual rate of return. You divide the number 72 by the annual interest rate (expressed as a percentage) to get the approximate number of years required to double the investment.

Formula:

Years to Double=72/Annual Rate of Return

Example Calculation:

• If you have an investment with an annual return rate of 8%, the Rule of 72 suggests: Years to Double: 72/8=9 years. This means it will take approximately 9 years for your investment to double at an 8% annual return.

Applications:

• Investment Growth: Investors can use the Rule of 72 to estimate how long it will take their investments to double at different rates of return (stocks, bonds, mutual funds).
• Inflation: The rule can also help estimate how quickly the purchasing power of money will halve due to inflation. For example, if inflation is 3%, the purchasing power of money will halve in approximately 24 years: Years for Purchasing Power to Halve=72/3=24 years.

Limitations:

• Approximation: The Rule of 72 is an estimate, so it becomes less accurate for very high or low interest rates.
• Annual Compounding Assumed: The rule assumes that interest is compounded annually. If compounding occurs more frequently (e.g., quarterly), the actual doubling time may be slightly different.

Overall, the Rule of 72 is a quick, useful mental shortcut for evaluating the growth of investments or the effects of inflation.