How Long to Double Your Money - the Rule of 72

There are several formulas learned in high school algebra math class or geometry math class that I use in everyday life. I do not use them every day, but they come in useful a number of times each year and in a variety of cocktail party discussions. I use them at times I do not have access to a calculator and have to do a mental calculation. One of these formulas is the Rule of 72, or Rule 72, or the 72 Rule. This formula essentially returns the answer to the question “How long will it take to double my money”.

The Rule of 72 simply states that for a given interest rate, then 72 divided by this interest rate will equal the number of years it will take for the principle amount to double. For example, if I have $100, how long will it take for me to have $200 if I earn 4% per year interest. The answer is 72 divided by 4 (72/4) or 18 years. If I earn 6% interest, the answer would be 12 (72 divided by 6).

The Rule of 72 can also be used in reverse. For example, what interest rate would I need to earn to double my money in 10 years? Answer 7.2 years (72/10)

Assumptions and conditions for the Rule of 72:

· Compounding of interest is Annual or Simple Interest. This formula does not work exactly if you are using daily or monthly compound interest.

· The principle amount is static or set. The rule assumes that you do not add or subtract any money during the period. So you could not use this formula when discussing a mortgage or your 401k assets.

Why is the Rule of 72 Useful?

I tend to use the formula when contemplating or comparing a new investment such as a Bank CD, or telling a person how much inflation will affect their retirement savings down the road, or just about any projection which involves a set amount of money without new contributions. Even if the compounding period is daily or monthly, or if additional contributions are assumed, the Rule of 72 can give you a “feeling” for the projected answer if your mind can understand how interest rates and percentages work.

 

 

Danger in using the Rule of 72

If you mind does not think in percentages, then you could easily misuse the Rule of 72 if there is not a set amount of money or if the compounding period is different than Annual. Try this question:

· if your investment portfolio lost 50% of its value in the 2008 stock Market crash, what percentage increase in your portfolio do you need to get back to even? Many people answer 50% increase, on the quick assumption that if they lost 50%, then they need to gain 50%. Wrong! If you portfolio dropped 50%, you need a 100% gain in the portfolio to get back to where you were before the drop. For a further explanation of this financial phenomenon, Click on this: Struggling to Get Back to Even after the 2008 Stock Market Crash

If you had a problem with the forging question, do not use the Rule of 72 unless you are dealing with only one set amount and the compounding period is Annual. Otherwise, you risk being very wrong in your projections.