A basic concern of anyone who invests in stocks, bonds or other financial instruments is how quickly the investment will grow, and in particular how soon it may double in value. The Rule of 72 can help you determine how may years it will take an investment (or even a debt) to double in value.
There are a variety of somewhat complex mathematical equations, many of which require a calculator, that can provide an answer. However, there is a simple mental calculation that has been around for hundreds of years that can quickly provide a reasonable estimate of how long it will take to double your investment. It is called the Rule of 72. Just divide 72 by the rate of return, and that is how many years it will take to double your money.
The Rule of 72 is a financial literacy rule that has been around in one form or another since the late 1400s. It applies to investments that generate compound interest or for which the earnings or capital gains are simply rolled over and kept as part of the investment. It is a great, quick and simple calculator for many investments, in particular equity investment. Since the Rule of 72 tell you how many years an investment will take to double in value, it is a great financial literacy concept for teenagers, kids, teens, and younger investors to know as they have time on their side. The rule does not apply to investments that earn simple interest but the Rule of 72 is for Compound Interest investments or rate of returns.
How does the rule of 72 work with compound interest or investments
If you buy $1000 is stocks, ETF, bonds, or mutual funds, and it grows 5% annually compounded, the account will increase in value $50 the first year. However, in the second year, the return is calculated on the total account balance of $1050 and results in earnings of $52.50. The financial return in the third year is calculated on the new account balance of $1102.50, and this pattern continues year after year. Compounding annual returns is this type of investment to which the Rule of 72 applies.
Note the Rule of 72 does not work with simple interest investments. While those types of investments are not common, a simple account will only pay interest on the principal investment. If your initial investment is $1,000 and earns simple interest at an annual rate of 5%, you will earn $50 year after year. Compare that too compound interest. That type of investment will pay interest (or the return is calculated) not only on the original principal but on all accrued interest. As a result, the interest earned or total return increases every year.
Calculating length of time to double your investment using the Rule of 72
To use the Rule of 72 all you really need to know is the percentage rate used to calculate annual earnings. The rule tends to be most easiest to understand when earnings are about 8% annually. To obtain a fairly accurate estimate of the length of time it will take $1,000 to double in value if it earns 8% a year, you simply divide 72 by the rate of return for the investment (8) (or the interest rate (8)) for an answer of 9 years. If the rate of return is 6% per year, dividing 72 by 6 results in an estimate of 12 years to double the investment value.
For many investors, annual earnings of 8% are a realistic expectation. The S&P 500 is a stock index that measures the stock performance of 500 large companies. The index is commonly relied upon by investors as the most accurate predictor of stock value over time. While the index has experienced both increases and decreases of more than 30% in a few specific years, over the 24-year period ending with 2018 the annual growth rate was 8.5%.
Assuming your investment earns approximately 8% per year, you can realistically expect it to double every nine years. That is 72 divided by rate of return of 8%, and that equals 9. Your $5,000 investment at age 20 would be worth $10,000 at age 30 and $20,000 after ten more years. These calculations all assume that you do not add any further funds out of your own pocket. If you do add more to the principal, the account will grow in value even faster.
Calculating the interest rate to double your investment
The Rule of 72 can also be used to determine the interest or earnings rate at which you must invest to double your investment over a specific period of time. If you have a $5,000 investment and want it to double in value in 10 years, just divide 72 by the number of years (10) to find you need to invest at a compound interest rate of 7.2% to achieve your goal. If you allow 12 years to double your investment, divide 72 by 12 to find that your investment needs to earn 6% annually.
The Rule of 72 can be applied not only to investments but to inflation, population, bills or anything else that grows over time. It is a great financial literacy rule to know as the Rule of 72 is powerful. For example, if you have a credit card with a $2,000 balance carrying an annual interest rate of 24% and pay nothing on that bill, your balance, not including late fees, will double to $4,000 in three years. This is determined by dividing 72 by 24 (interest rate) to obtain the number of years (3) required to double the bill’s balance.
While best results come from using an 8% annual interest rate, the Rule of 72 remains fairly accurate for calculations involving interest rates between 6% and 10%. There are small variations on the rule that may increase accuracy outside this range, but for most purposes, the basic rule is fine for rough calculations.
The Rule of 72 is a quick, simple financial literacy tool to determine if your investments, stock portfolio, 401(k) or other retirement accounts will be adequate when needed. It can show how long your financial investments will double in value. This calculation can easily show you whether you may need to move some funds earning low annual returns into investments with higher interest rates or whether the time before retirement remains sufficient to achieve your investment goals. To enjoy the best results, just remember to invest broadly, remain patient during volatile times and reinvest your earnings.
The Rule of 72 is powerful for teenagers and children
As with any type of investment made, the more years that someone has for their investment to grow, the easier it is to build wealth. This is why the Rule of 72 is even more beneficial for younger investors and savers. Teenagers, children, college students, and the youth in general need to know how this financial literacy concept works and how it can benefit them in a powerful way.
Lets say that an 18 year old starts to invest in the stock market. They invest into “safe” mutual funds, an ETF, or S&P 500 index fund. While the rate of return can increase or decrease over time, if get on average a return of 8% per year, that means that initial $1,000 investment will double every 9 years. (Once again, the formula in this example is 72/8 = 9.). See the example below as to how their money will grow.
Since their money will double every 9 years, the earlier someone starts to save and invest the more years they have for their money to double. Lets look at this example further. If an 18 year old started investing, and if they earn that 8% per year, they will have their money double every 9 years.
That means if they started with $1,000 at age 18, and average 8% per year, that investment will be worth $2,000 at age 27. Then that $2,000 will double again in 9 years, so the teenager will then have $4,000 at age 36. It will double again at age 45, and it will be worth $8,000 at that point. Another double will take place by age 54, and that $1000 initial investment will now be worth $16,000. Another 9 years goes by, and the money will double again over the course of that time. This means age 63, that $1,000 initial investment will be worth $32,000. Then it grows again at age 72 to $64,000. The bottom line is that the initial $1,000 investment that was made at 18 years of age will be worth $64,000 by age 72. A teenager can save $1000 by age 18, never add another cent to that investment, and it will grow to $72,000. $1000 turn into $72,000. This is why the Rule of 72 is something that every younger American should know about.
A teenager or kid who starts to invest early can really build wealth. The Rule of 72 shows how it works, and how kids benefit. A younger person can invest. Maybe they do this using money from a job or hobby, or even funds from their parents or loved ones, to get started. The Rule of 72 can help younger people save, build up investment accounts, and put them on the path of long term financial stability and even retirement. A teenager or kid can build retirement and long term savings if they invest early, and the Rule of 72 shows how that can happen.
By Jon McNamara