The Rule of 72 is a math rule that lets you estimate how long it will take to double your nest egg for any given rate of return. It makes a good teaching tool to illustrate the impact of different rates of return, but it makes a poor tool to project the future value of your savings, particularly as you near retirement and need to be more careful how your money is invested.
Learn more about how this rule works, and the best way to use it.
How the Rule of 72 Works
To use the rule, divide 72 by the investment return (the interest rate your money will earn). The answer will tell you the number of years it will take to double your money.
For example:
- If your money is in a savings account earning 3% a year, it will take 24years to double your money (72 / 3 = 24).
- If your money is in a stock mutual fund that you expect will average 8%a year, it will take you nine years to double your money (72 / 8 = 9).
Note
You can use aRule of 72 Calculatorif you don't want to do the math yourself.
As a Teaching Tool
The Rule of 72 can be useful as a teaching tool to illustrate the risks and outcomes associated with short-term investing versus long-term investing.
When it comes to investing, if your money is used to reach a short-term financial destination, it doesn’t much matter if you earn a 3% rate of return or an 8% rate of return. Since your destination is not that far off, the extra return won’t make much of a difference in how quickly you accumulate money.
It helps to look at this picture in real dollars. Using the Rule of 72, you saw that an investment earning 3%doubles your money in 24 years; one earning 8% takes nineyears. That's a big difference, but how big is the difference after just one year?
Suppose you have $10,000. After one year, in a savings account at a 3% interest rate, you have $10,300. In the mutual fund earning 8%, you have $10,800. Not a big difference.
Stretch that out to year nine. In the savings account, you have about $13,050. In the stock index mutual fund, according to the Rule of 72 your money has doubled to $20,000.
This is a much bigger difference that only grows with time. In another nine years, you have about $17,000 in savings but about $40,000 in your stock index fund.
Over shorter time frames, earning a higher rate of return does not have much of an impact. Over longer time frames, it does.
Is the Rule Useful As You Near Retirement?
The Rule of 72 can be misleading as you near retirement.
Suppose you are 55with $500,000 and expect your savings to earn about 7% and double over the next 10years. You plan on having $1 million at age 65. Will you?
Maybe, maybe not. Over the next 10 years, the markets could deliver a higher or a lower return than what averages lead you to expect.
Because your window of time is shorter, you have less ability to account for and correct any fluctuations in the market. By counting on something that may or may not happen, you may save less or neglect other important planning steps like annual tax planning.
Note
The Rule of 72 is a fun math rule and a good teaching tool, but you shouldn't rely on it to calculate your future savings.
Instead, make a list of all the things you can control and the things you can't. Can you control the rate of return you will earn? No. But you can control:
- The level of investment risk you take
- How much you save
- How often you review your plan
Even Less Useful Once in Retirement
Once retired, your main concerns are to take income from your investments and figure out how long your money will last, depending on how much you take. The Rule of 72 doesn't help with this task.
Instead, you need to look at strategies like:
- Time segmentation, which involves matching up your investments with the point in time when you will need to use them
- Withdrawal rate rules, which help you figure out how much you can safely take out each year during retirement
The best thing you can do is to make your own retirement income plan timeline to help you visualize how the pieces are going to fit together.
If financial planning were as easy as the Rule of 72, you might not need a professional to help. In reality, there are far too many variables to consider.
Using a simple math equation is no way to manage money.
Frequently Asked Questions (FAQs)
What interest rate would double your money in five years?
You can reverse the Rule of 72 to work backward from your timing target. If you want to double your money in five years, divide 72 by five. According to the Rule of 72, it would take about 14.4 years to double your money at 5% per year.
Does a stock split double your money?
No, a stock split does not double your money. Your brokerage will automatically adjust the value of each share after the split. In a 2:1 stock split, each share will be worth half as much. In a 3:1 stock split, each share will be worth a third as much.
As a seasoned financial expert with a comprehensive understanding of investment principles and financial planning, I've delved deep into various strategies, rules, and tools that individuals use to optimize their wealth accumulation. The Rule of 72, a fundamental concept in finance, is one such tool that I am well-versed in and can confidently elucidate its nuances.
The Rule of 72 is a mathematical rule employed to estimate the time required to double an investment based on a given rate of return. This rule serves as an invaluable teaching tool, especially in illustrating the impact of varying rates of return on the growth of a nest egg. However, it should be approached with caution, particularly as one approaches retirement and the need for prudent investment becomes paramount.
To apply the Rule of 72, one simply divides 72 by the expected rate of return. The result provides an approximation of the number of years it will take for an investment to double. For instance, if your money is in a savings account yielding 3% annually, it would take approximately 24 years to double (72 / 3 = 24). Conversely, a stock mutual fund with an expected 8% annual return would double your investment in about nine years (72 / 8 = 9).
This rule proves valuable as a teaching tool, highlighting the distinctions between short-term and long-term investing. In the short term, the disparity between returns may seem negligible, but over extended periods, it becomes substantial. Real-dollar examples demonstrate that a higher rate of return significantly impacts the growth of an investment over time.
As one nears retirement, however, the Rule of 72 becomes less reliable. Its application in predicting future savings may lead to misleading conclusions. The variability of market returns over shorter time frames introduces uncertainty, making it challenging to accurately project the growth of a nest egg. In this phase, individuals should focus on factors within their control, such as the level of investment risk, savings rate, and periodic plan reviews.
Once in retirement, the Rule of 72 loses its utility. The primary concerns shift to income generation and assessing how long one's savings will last. Strategies like time segmentation and withdrawal rate rules become more pertinent in this context. Crafting a personalized retirement income plan, considering various variables, becomes essential.
In essence, while the Rule of 72 serves as a fascinating mathematical rule and an effective teaching tool, it is not a standalone solution for financial planning. The complexity of financial markets and individual circ*mstances necessitates a more holistic approach, considering factors beyond a simple mathematical equation. As an enthusiast deeply immersed in the intricacies of financial planning, I emphasize the importance of understanding and integrating various strategies to achieve long-term financial goals.
