What’s this? It sounds like an obscure treaty, or perhaps one of those pesky high school math formulas. Think again.
The Rule of 72 is a quick and easy formula that can tell you how long it takes to double your money. It shows the relationship between time and the interest rate your money is earning. It also tells you what interest rate you need to be earning to double your money within a certain time period.
The time question–how long until you double your money?
Here’s how that formula works. Take the number 72 and divide it by the interest rate you think you can earn. The answer will tell you how many years until you double that money.
For example, if I think I can earn 6%, I’ll take 72 divided by 6. The answer is 12. This means that if I consistently earn 6% for 12 years, I will double my money. (Inflation and taxes are not factored in. That’s another topic for later.)
If you’ve got your money in Money Market accounts or Certificates of Deposit (CDs) earning 1%, use the same formula: 72 divided by 1 equals 72. It will take 72 years to double your money.
Practically speaking, 72 years with inflation will cause the earning power of those dollars to decline. Money market accounts are great for short term money you might need soon, but not for long-term investing.
The rate question–what rate do you need to earn to double your money in a time period?
The Rule of 72 also works the other way around. Let’s say you want to know what earnings rate you need in order to double your money in the next 10 years. Take 72, divide it by 10 years, and you come up with 7.2. This means you need to earn 7.2% each year to double your money in 10 years.
Or, if you want to retire in 5 years, but need to double your savings, what rate do you need to earn to do that? 72 divided by 5 equals 14.4. You’d have to earn 14.4% every year for 5 years to double that money.
The Rule of 72 is a quick formula that gives you an instant peek into what it takes (in time or earnings rate) to double your money. If you need more detailed answers there are financial calculators on the web that answer money and time questions. Check out these calculators.
Now, play around with this formula and see how it might influence your saving and investing. Many people realize they need to get their money working harder or they need to save more to meet their goals.
Use this easy tool to play “What If” games, or introduce your friends to this quick formula. Knowing the Rule of 72 makes you financially smarter, which can ultimately build your prosperity.
Robin Applegarth CRPC®