Understanding the Rule of 72: A Simple Way to Calculate Your Investment / Debt Growth

When it comes to growing your wealth through investments, the Rule of 72 is a simple but powerful concept that can help you estimate how long it will take for your money to double at a given rate of return.

Italian mathematician Luca Pacioli, often considered the father of accounting, first introduced the Rule of 72 in 1494. Investors and financial planners often use this rule because it provides a quick, easy way to gauge the potential growth of an investment without needing complicated formulas or a financial calculator. In this blog post, we’ll explain the Rule of 72 in detail, show you examples of how it works, and discuss its applications in personal finance.

What is the Rule of 72?

The Rule of 72 is a formula used to estimate the years it will take for an investment to double based on a fixed annual rate of return. Divide 72 by the annual rate of return (expressed as a percentage), and the result will give you the approximate number of years needed for your investment to double.

Formula:

72 divided by the interest rate or the rate of return equals the time to double​

This rule works best for interest rates that are compounded annually. While it's not 100% precise, it provides a quick, valuable estimation for long-term planning.

How Does the Rule of 72 Work?

Let’s examine some examples to see how the Rule of 72 works.

Example 1: Stock Market Investment

Suppose you are considering investing in the stock market. Historical returns suggest that you might earn an average annual return of 8%.

Using the Rule of 72, we can calculate how long it will take for your investment to double:

72 divided by 8 equals 9.

So, if you invest at an average annual return of 8%, your investment will take approximately 9 years to double.

This means that your money will grow by a factor of 2 every 9 years, assuming the rate of return remains consistent.

Example 2: Bond Investment

Let’s say you’re considering investing in bonds, which historically provide a lower rate of return. If you can earn an annual return of 4% on your bond investment, here’s how you can apply the Rule of 72:

72 divided by 4 equals 18.

At an annual return of 4%, your investment will double in approximately 18 years. While the return is lower than the stock market example, it still gives you a sense of how long it will take for your money to grow.

Example 3: High-Interest Savings Account

Let’s say you have a savings account offering a 1% interest rate. If you want to know how long it will take for your money to double, you can apply the Rule of 72 again:

72 divided by 1 equals 72.

At 1% interest, your money will double in 72 years. While this isn’t an excellent rate for growing your wealth, the Rule of 72 clearly shows how slow that growth will be.

Example 4: Credit Card Debt (Negative Growth)

Conversely, the Rule of 72 can also be used to understand how quickly your debt will grow if you pay high interest rates. For instance, if your credit card has an annual interest rate of 18%, you can calculate how long it will take for your balance to double if you only make minimum payments:

72 divided by 18 equals 4 years

If you don't pay off your credit card debt at an 18% interest rate, it will double in four years. This is why paying off high-interest debt quickly is essential—it can grow exponentially, and the Rule of 72 highlights how damaging this can be.

Why the Rule of 72 is Useful

The Rule of 72 is valuable for a few reasons:

1. Quick Mental Math: You don’t need a financial calculator or complex formulas to understand how long your investment will take to grow.

2. Risk Assessment: It helps you assess whether the returns on an investment are worth the risk. For example, an 8% return may sound promising, but when your money will only double every 9 years, you may question whether that rate is enough for your financial goals.

3. Debt Management: It can also help you understand how quickly debt, especially high-interest debt, can grow. This can motivate you to pay off high-interest loans and credit cards faster.

Limitations of the Rule of 72

While the Rule of 72 is an excellent tool for quick estimates, it does have some limitations:

1. Assumes a Fixed Rate of Return: The Rule of 72 assumes that the interest rate is fixed and constant over the years, which is rarely the case in real life. Market returns fluctuate, and interest rates may change.

2. Doesn't Account for Compounding Frequency: The formula assumes annual compounding, but many investments compound more frequently (e.g., monthly or quarterly), which can slightly alter the actual time it takes to double your investment.

3. Long-Term Estimate: The Rule of 72 works best for long-term estimates and may not be as accurate for short-term predictions.

Conclusion

The Rule of 72 is a handy tool for quickly calculating how long it will take for your investments to double, based on a fixed rate of return. By using this rule, you can get a rough estimate of how long it will take for your savings to grow or for your debt to spiral out of control. However, it’s important to remember that this is just an estimate and shouldn’t be relied upon as the only tool for making investment decisions.

For example, if you’re planning for retirement or saving for a large purchase, understanding how long your money will take to double at a specific return can help you prepare better. Whether investing in stocks, bonds, or paying off debt, the Rule of 72 gives you a simple way to visualize your financial growth or losses over time.

"The time has come for all evangelists to practice full financial disclosure. The world is watching how we walk and how we talk. We must have the highest standards of morality, ethics and integrity if we are to continue to have influence."

Billy Graham