The Rule of 72 is a simple calculation that can be used to estimate the amount of time it will take for an investment to double, no calculator necessary! Well I concede, maybe a basic one…unless you can divide numbers like 3.4 into 72 in your head, in which case, props to you…but most probably can’t, so grab a simple four function calculator and you will be completing compound interest problems in no time!
I am going to invest $1,000 in a money market account with a yearly interest rate of 2%. To estimate how long it would take my $1,000 to become $2,000 I would divide 72 by the interest rate of 2 (72 / 2). The answer, 36, is about how many years it would take for my initial investment of $1,000 to double. The actual amount of time it would take is 35.003 years, as you can see; using this rule we can get fairly accurate answer with no complicated math!
Bonus uses for the rule of 72
There are two other ways this rule can be utilized. First we can use it to see the effect of inflation on our purchasing power and second, to determine the interest rate required to double an investment in a certain amount of years.
Purchasing Power Example:
The inflation rate is 4% and Jill has $5,000 in her emergency savings fund which earns no interest. She is concerned about the inflation rate and wants to estimate how long it will take for her savings to lose half its value due to inflation. Using the rule of 72 she divides 72 by the inflation rate, 4 (72 / 4) to estimate 18 years. If the inflation rate remains constant Jill can assume in roughly 18 years the buying power of her savings account will be halved. Meaning if she can buy 5,000 iTunes songs today for $5,000 she can expect the same $5,000 in 18 years to only purchase 2,500 iTunes songs.
Interest Rate Required Example:
Bill is ambitious and wants to double his money in 10 years, to figure out an approximate interest rate he would need to invest at he divides 72 by the number of years, 10 (72 / 10) to obtain 7.2. In order for Bill to double his money he will need to find an investment vehicle which yields 7.2% annually for 10 years if he is to achieve his goal.