What is the Rule of 72?

Choosing the right investments can be challenging. Figuring out how much money to invest and what a good return is can leave you scratching your head. A simple formula can help you choose investments that fit your financial situation. Known as the Rule of 72, this easy-to-use formula helps you intuitively evaluate an investment's return. Learn how to use the Rule of 72 formula to guide investment decisions. 

How Does the Rule of 72 Work?

The Rule of 72 is a simple method to estimate how long it takes to double your investment. By taking a given rate of return, you can quickly calculate the time it takes to double your money.

The formula does not provide a precise calculation; instead, the Rule of 72 is helpful as a quick back-of-the-envelope approach. 

The Rule of 72 is a mathematical formula dating back to 1494 featured in Luca Pacioli’s textbook, "Summa de Arithmetica." This mathematical calculation was soon included in accounting books, earning Pacioli the title of "Father of Accounting and Bookkeeping.”

Rule of 72 Formula

The Rule of 72 relies on a simple calculation to estimate how long it takes for your investment to double. The formula looks like this:

Year to Double Investment = 72 / Annual Rate of Return

The simplicity of the Rule of 72 requires only a few variables.

• Constant factor of 72 in the numerator
• Investment’s estimated annual return

Your first step is to estimate the investment’s annual rate of return. Determining the annual interest rates is easy when the investment has a guaranteed rate of return. 

However, if market conditions influence the investment's rate of return, estimating the yearly return often comes down to making a good guess. You may also consider the expected growth rate, interest rates and inflation rate when estimating the investment’s annual return.

Once you have nailed down the estimated annual return, divide this into the constant 72 number. For example, if you expect an annual return of 8%, the Rule of 72 formula would look like this: 

x = 72 / 8

x = 9

The above calculation reveals that you will double your money in 9 years when the investment produces an 8% yearly return.

Let’s say you know how many years you need your investment to double. Using the Rule of 72, you can determine the annual return required to meet your goal.

The formula would look like this: Annual Rate of Return = 72 / Years to Double Investment.

Key variables include:

• Constant factor of 72 as the numerator
• Time in years

If you want to double your money in 6 years, the Rule of 72 formula would look like this:

x = 72 / 6

x = 12

Based on the Rule of 72 formula, you will double your money in 6 years with an investment producing a 12% annual return. 

Practical Examples of the Rule of 72

Let's look at a few examples to better understand how the Rule of 72 works.

Assume you plan to invest $10,000 in an investment with an annual return of 6%. If you want to know how long it would take to double your money, the Rule of 72 formula would look like this:

 x = 72 / 6

x = 12

Using the Rule of 72, your $10,000 investment grows to $20,000 in 12 years.

However, if you find an investment with an estimated 8% annual return, your money doubles in 9 years (72 / 8). With a 9% annual return, your investment doubles in 8 years (72 / 9).

Additionally, you can calculate the necessary return you need if you already know how much time you want your investment to double.

For example, if you want your $5,000 investment to double in 8 years, the Rule of 72 formula shows “x” as the estimated annual return: 

x = 72 / 8

x = 9

The investment must return at least 9% annually to double your money in 8 years. 

Importance and Limitations of the Rule of 72

The Rule of 72 takes some of the guesswork out of understanding what your rate of return means. This easy formula provides a quick way to estimate how many years it takes to double your investment.

The Rule of 72 formula is a handy tool to evaluate investments, but it has limitations. The Rule of 72 formula is a simplified version of a more complex logarithmic calculation, so the result is only an approximate value.

The Rule of 72 calculation assumes the stated rate of return remains stable. If the investment’s rate of return is affected by market fluctuations, the results are less accurate when predicting investment growth. While using the past performance of an investment to estimate its annual rate of return is often a starting point, you should keep in mind that past activity doesn’t guarantee future performance.

Another drawback of the Rule of 72 is the constant factor used. Dividing the 72 by interest rates ranging between 6% and 10% yields the closest results to the more complex logarithm. The results of the Rule of 72 are even less accurate for yearly rates that fall outside of this range. While you can still get a general idea of how many years it takes to double your money, you may need a more complicated calculation for greater accuracy.

While the Rule of 72 doesn’t guarantee accuracy, the calculation helps give you a close timetable. Based on the estimated rate of return, you may need to tailor the formula to meet your specific situation. 

The Rule of 72 and Compound Interest

The Rule of 72 illustrates how compounding builds long-term wealth. When your investments compound interest, your return is calculated on your entire investment. So, you earn money from what you have invested and earned. Under the simple interest method, you earn money only on what you have invested.

To illustrate, assume you invest $1,000 with an expected 10% rate of return. The Rule of 72 calculation shows you double your money in 7.2 years (72 / 10).

If your earnings are based on simple interest, like you might get in a savings account, you’ll earn $100 yearly ($1,000 x 10%). Your investment takes ten years to double if you make $100 annually. 

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Use the Rule of 72 to Guide Your Investment Decisions

One of the biggest questions you might have when investing is how quickly your money grows. The Rule of 72 is a simple calculation you can make by using a few factors. With the Rule of 72, you can easily estimate how many years it takes to double your investment without the need for complex calculations. 

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