Did I have you at “double your money”?
You can double your investments quickly if you get a great rate of return thanks to the power of compound interest. But, how will you know what rate of return you need to double your money in the next 3, 5, or 10 years? Well, there’s a formula for that and it’s called the Rule of 72.
The Rule of 72 is not just any formula. It’s a time-tested formula used by both old and new investors every day to estimate the amount of time it will take to double their investment - whether it is in a particular stock, a retirement account, or a savings account.
I use the Rule of 72 all of the time, and chances are, if you’ve listened to InvestED or read either of my books, you’ve seen how I use it.
It’s simple to learn and easy to use, so it’s a great tool for all Rule #1 investors to have in their back pockets.
What is the Rule of 72?
The Rule of 72 is a simple equation to help you determine how long an investment will take to double, given a fixed interest rate.
It’s a shortcut that you, as an investor, can use to estimate if an investment will double your money quickly enough to be worth pursuing. When you see how quickly your money can double, you’ll understand the power of compound interest.
What is Compound Interest?
Compound interest is what makes you wealthy over time; the longer time your money is invested, the more it grows.
How? Well, as you earn interest on your initial investment, those earnings are added to the initial amount while earning interest. This produces more earnings, which can then be reinvested as well.
It’s a powerful cycle that can lead to incredible growth. The Rule of 72 paints a picture of how quickly your money can grow without any additional investment on your part.
Getting a sense of how compound interest can potentially grow your investment portfolio should be enough to light a fire under you and initiate your desire to start saving as early as possible, even if you only have a small amount.
The Rule of 72 Formula
You don’t need a special ‘Rule of 72’ calculator to figure out this equation—it’s easy.
Simply divide 72 by the fixed annual rate of return and you’ll know how many years it will take for your money to double.
72 / rate of return = # of years
If you’re trying to compute when your money will double at a given interest rate, this formula can be used to determine the interest rate you need your money to double in a set timeframe:
72 / # of years = rate of return
For more complex equations related to evaluating your investments, use my investment calculators to crunch the numbers.
Examples of the Rule of 72
The most basic example of the Rule of 72 is one we can do without a calculator:
Given a 10% annual rate of return, how long will it take for your money to double? Take 72 and divide it by 10 and you get 7.2. This means, at a 10% fixed annual rate of return, your money doubles every 7 years.
Let’s try another one:
Given a 9% interest rate, how long will it take to double your money? Divide 72 by 9 and you’ll get 8 years.
Let’s relate this to a real-life event now:
OK, now let’s apply this to a scenario where you already know the number of years you need to double your money, so you need to solve what the interest of your investment will be. You just need to reverse the equation.
Say you want to double your money in 3 years so you can put a down payment on a house.
Divide 72 by 3 to get 24. You will need a 24% rate of return on your investment. If you later decide not to buy the house and you left your money invested for another 6-7 years, then it would double two more times!
If you started with $10,000, then after three years you would have $20,000. After another three years, you would have $40,000, and after another three years, you would have $80,000. That’s eight times more than what you started with, plus it only took nine years given a 24% annual rate of return.
That’s the power of compound interest—what makes investing an incredible way to grow your wealth over time.
Drawbacks of the Rule of 72
Remember, the Rule of 72 is an estimation, it’s not exact.
Take the example above. When saving up to put a down payment on a house, the exact number of years it takes to double an investment at a 24% growth rate is 3.2 years. While this is extremely close, it’s not 100% accurate.
The Rule of 72 is the most accurate with fixed interest rates around 10%, but the farther you get from 10%, the less accurate it becomes.
When investing in stocks, you won’t experience a fixed annual rate of return. The stock market is volatile and doesn’t guarantee consistent returns, especially in the short term.
This is why we evaluate a company thoroughly before investing in it so we know what average annual rate of return we can expect over the next five to ten years.
For our purposes, the Rule of 72 is accurate enough to give us a general idea of when we can expect our money to double.
When to Use the Rule of 72
So now you’re wondering when to use the Rule of 72. There are so many scenarios where this easy formula can help you—from planning for the future and evaluating an investment to understanding the impact of debt.
To Plan for Financial Goals
Like the example above, you can use the Rule of 72 to determine when you will be able to make a big future purchase, like a house. But, it also can be useful for a lot of other financial goals you have.
If you have financial goals where you want to know how long it will be until you meet them, or you want to know what interest rate you need in order to reach your 5 or 10-year goals, then use the Rule of 72.
For instance, if you need $100,000 to pay for your kid’s college in 10 years, and you start with $50,000, then you’ll need a 7.2% (72 / 10) annual rate of return on your investment.
But, if you start with $15,000, you’ll need your money to double 3 times in the next 10 years. This means you’ll want your money to double every 3.3 years and with a 21.8% (72 / 3.3) annual rate of return on your investment.
If you are investing for retirement, the Rule of 72 can be extremely beneficial. The amount of money you will need for retirement is a big number, but if you start early, even a small amount of money can double over and over again.
The Rule of 72 will tell you: The less time you have until you retire, the larger the annual rate of return you will need on your investments.
ON the other hand - if you have a long time until you plan to retire, you may be able to aim for a smaller annual rate of return.
To Evaluate Investments
You can also use the Rule of 72 to evaluate your investments. Of course, this is how I use it most.
If I’m comparing two potential investments and one will give me an 18% average annual rate of return, and the other is 14%, then I will double my money a year sooner if I go with the investment that could produce an 18% annual rate of return on average.
If I leave the investment alone for 15 years, the first option will nearly double almost 4 separate times, while the second option will have only doubled 3 times.
To Better Understand Debt
Just as compound interest works for you when you have money invested, it will also work against you when you have debt.
Say you have credit card debt with an annual interest rate of 20%. Even if you make the minimum monthly payments on that card and don’t spend anything else, the amount you owe will double in 3 and a half years. Yikes.
So, if you have debt, the Rule of 72 will hopefully light a fire under you to get rid of it as quickly as possible.
How To Double Your Money
The Rule of 72 teaches us that a wonderful investment that produces high returns will help double your money fast.
I like to target an average annual growth rate of 26%.
This means my money will double every 3 years. But you can’t get these high returns with just any investment. You have to pick the right companies that will generate great returns year over year.
To get a great return on your money, first, you have to learn how to invest. Join me at my next Free Investing Webinar to learn, not only the basics of investing but also know how you can find incredible companies that will give you that 26% annual return.
Once you know this, you’ll be able to experience the magic of compound interest for yourself and double your money in no time.
