Investment is all about making wealth and most of the time it is goal-driven. We generally invest in assets by observing their past performance, which gives us a fair idea of how much return we can expect in a given period. Sometimes we need to find how long it will take to make 100% returns or 2X the invested money. For this very reason, there is Rule of 72 which gives us a fair idea of the time taken to make the invested amount 2X.
The number 72 is used in investment calculations as a quick and easy way to estimate the time required for an investment to double in value based on a given interest rate or rate of return. This is known as the “rule of 72.”
To use the rule of 72, you simply divide the number 72 by the expected rate of return on investment. The resulting number represents the approximate number of years it would take for your investment to double in value. One thing to note is that this rule of 72 only applies to investments which are giving compounded annual returns.
For example, if an investment offers a 6% rate of return, you would divide 72 by 6, which equals 12. This means that it would take approximately 12 years for your investment to double in value with a 6% rate of return.
It is important to note that the rule of 72 is not truly accurate this value is taken because it is close to mathematical value which is divisible by multiple numbers.
How we came to Rule of 72
The Rule of 72 is based on mathematical calculations. The formula is derived from the compound interest formula, which is:
Future Value = Present Value x (1 + rate) ^ time
Where:
- Future Value is the value of the investment in the future
- Present Value is the current value of the investment
- Rate is the annual interest rate
- Time is the number of years
To calculate the number of years required to double the investment, we can rearrange the formula as follows:
2 = 1 x (1 + rate) ^ time
Taking the natural logarithm of both sides, we get:
ln(2) = ln(1 + rate) x time
0.693 = time x rate/100 (assuming that ln(1+rate) = rate as interest rate approaches zero )
Simplifying further, we get:
time = 69.3 / rate
This calculation gives us the rule of 69 and this is more accurate when we need to find the precise time taken by an investment to double in value, but the 69 is not so calculation-friendly as this number does not have multiple factors so for ease of calculation we come up with a number which is close to 69 and with which it is easy to do the calculation. The rule of 72 applies well to interest rates that fall in the range of 6% and 10%. For different interest rates, this rule changes to Rule of 71, 73 etc.
Advantages of Rule of 72
Easy to Use: The rule of 72 is a simple and easy-to-use method for estimating investment returns. It only requires knowledge of the expected annual rate of return and will give you the time it takes to double the investment or vice-versa.
Helps in Comparing Investment Options: By using the rule of 72, investors can compare the potential returns of different investment options, making it easier to select the best option.
Applicability: This rule just not only applies to investment it can also be used for calculating the impact of inflation on savings, GDP growth etc.
Disadvantages of Rule of 72
Assumes Constant Return: The rule of 72 assumes that the rate of return on the investment is constant over the investment period. Not valid for changing interest rates.
Applicable on a certain rate of return: This rule holds good when the rate of return is around 6-14%.
Accurate: This rule is not as accurate as other rules which are the rule of 69 and 70. This 72 value is chosen because 72 has multiple factor(2, 3, 4, 6, 8, 9, 12, etc.) which helps in making calculation quickly.
Different Rules with Varying Rate of Return
| Rate of Return | Rule of |
|---|---|
|
3-5% |
71 |
|
6-10% |
72 |
|
11-13% |
73 |
|
14-16% |
74 |
Words of Wisdom
“If saving money is wrong, I don’t want to be right!” ― William Shatner
Key Takeaways
- This rule tells us about how much time an investment will take to get doubled with a given rate of return.
- This rule applies to anything that grows with a compounded rate, like inflation, interest rate, GDP etc.
- This Rule applies reasonably well for rates of return that fall in the range of 6% and 10%.
- This is an approximate formula and it also changes with situations. If we want an exact answer then it is better to use the rule of 71, 73 etc, for different rates of return.
Conclusion
The rule of 72 is a simple and useful method for calculating the time it takes for an investment to double with the given rate of return. With the help of this rule, we can easily compare the various investments and the time it takes to achieve the investment goal. However, the rule of 72 does not give precise results and is valid for a range of rates of return, which may not always be the case. This rule changes to different rules for different rates of return like 70, 73 etc. when the rate of return changes. Therefore, it should be used as a general guideline rather than a definitive rule for investment planning.
Thank you for taking the time to read this blog post! I hope you found the information helpful and informative. If you have any thoughts or feedback, I’d love to hear from you in the comments section below. You can also follow me on social media to stay up to date with my latest posts and updates.
