In You’re Spending Your Millions $1 at a Time, you learned that compound interest has the power to turn seemingly small amounts into large fortunes if given enough time and the right rate of return. This article discusses the so-called Rule of 72. This rule allows the investor to quickly and efficiently answer two questions:
- How long will it take me to double my money if I earn X%?
- What return must I earn if I wish to double my money in X years?
Using the Rule of 72 When the Rate of Return Is Known
An investor that knows he can earn 12% on his money may ask the question, “How long will it take to double my money at this rate of return?”.
Using our handy Rule of 72, this is a snap to calculate! Simply divide the magic number (72) by the investor’s rate of return (12). The answer (6) is the number of years it would take to double the investment.
Using the Rule of 72 When the Number of Years Is Unknown
The Rule of 72 can also be used in reverse. An investor who wanted to double his money in a certain number of years could use the rule to discover the rate of return he would have to earn to achieve his goal.
Imagine, for a moment, a businessman who wanted to double his money in four years. To estimate a rough rate of return required to achieve such a feat, he'd divide 72 by 4. The result (18%) is the after-tax compound annual rate of return he would have to earn to meet his goal on time.
Practical Examples of the Rule of 72 in Action
Q: John Q. Investor needs to double his money in seven years to reach his financial goals. What rate of return must he earn to do this successfully?
A: John would take 72 divided by 7. The answer, 10.2857%, is the amount he will need to earn on an after-tax basis to successfully reach his goal.
Q: Susan Q. Investor is earning a 9% after-tax return on her investments. How long will it take her to double her money?
A: To calculate the number of years necessary to double her money using the Rule of 72, Susan would divide 72 by 9. The answer, 8, is the number of years it will take for her investment to double after taxes.