When we put our money in the market, or before we even do, one of the biggest questions we have is: How long will it take for this investment to really grow?
Luckily, there's a mathematical shortcut to help you estimate the future value of an investment. The Rule of 72 is a quick way to figure out approximately the number of years needed to double your invested money.
Using your rate of return, the Rule of 72 is a simplified formula that measures the effect of compound interest on your investment dollars. As a refresher, compound interest is calculated on your principal amount, plus your accumulated interest. It essentially pays interest on top of interest and is a huge perk of investing in the market since your interest earned is automatically reinvested, earning you even more.
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How to calculate the Rule of 72
To use the Rule of 72 formula, simply divide 72 by the expected annual rate of return. Take note that the formula assumes the same rate over the life of the investment.
As an example, say you invest $50,000 in a mutual fund that has a hypothetical 6% average rate of return. By using the Rule of 72 formula, your calculation will look like this: 72/6 = 12. This tells you that, at a 6% annual rate of return, you can expect your investment to double in value — to be worth $100,000 — in roughly 12 years.
When calculating the Rule of 72 for any investment, note that the formula is an estimation tool and the years are approximate. The Rule of 72 mainly works with common rates of return that are in the range of 5% to 12%, with an 8% return as the benchmark of accuracy. Lower or higher rates outside of this range can be better predicted using an adjusted Rule of 71, 73 or 74, depending on how far they fall below or above the range. You generally add one to 72 for every three percentage point increase. So, a 15% rate of return would mean you use the Rule of 73.
Keep in mind that a mutual fund or index fund are smart investing options, especially for beginners, as it offers instant diversification by pooling money from many individuals to invest in a collection of companies. They also offer somewhat predictable returns over the long run. For instance, have returned about an 11% average annualized return since 1950, be it with significant downward and upward swings in some years.
Robo-advisors likeWealthfront,BettermentandSoFiwill build you a portfolio of index funds (usually in the form of ETFs) based on your risk tolerance, time horizon and investing goals.These are good platforms to use when you're just starting out investing since robo-advisors automatically rebalance your portfolio for you and as you get closer to your investing targets. If you want more control over your investments consider a brokerage that doesn't charge commission fees, like Charles Schwab or Fidelity.
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The Rule of 72 and inflation
The Rule of 72 can also help you see how long it would take for the effect of inflation to cut your money in half.
As an example, say you have $100,000 and expect a hypothetical long-term inflation rate of 3%. Since inflation reduces your purchasing power over time, your $100,000, if not invested, would lose half its value (aka be worth $50,000) by 24 years. The calculation for this looks like: 72/3 = 24. If inflation increases from a rate of 3% to 6%, that same $100,000 would lose half its value even faster — in just 12 years (72/6 = 12).
Bottom line
The Rule of 72 is an easy way to quickly find out when your investments will double in value. It can also help you see how soon or far out inflation would eventually cut your money's value in half.
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I'm well-versed in investment strategies and financial tools, and the Rule of 72 is a fundamental shortcut for estimating investment growth. This rule calculates the approximate time required to double an investment based on the given rate of return. It's a neat trick that simplifies complex compound interest calculations. Compound interest, where interest is earned on both the initial amount and the accumulated interest, is a powerful force in growing investments.
The Rule of 72 formula is straightforward: Divide 72 by the expected annual rate of return to determine the approximate number of years needed for your investment to double. For instance, if you invest $50,000 at a 6% annual rate of return, the calculation would be 72 divided by 6, resulting in an estimated doubling of your investment in roughly 12 years.
It's essential to note that the Rule of 72 is an estimation tool and assumes a consistent rate of return throughout the investment period. This rule works best for rates between 5% to 12%, with 8% being its benchmark for accuracy. Deviations from this range may require adjustments using variations like the Rule of 71, 73, or 74 for more accurate predictions.
Mutual funds and index funds are recommended for beginners due to their diversification benefits and relatively predictable long-term returns. Historical data suggests that these funds have averaged around an 11% annualized return since 1950, despite fluctuations.
Robo-advisors like Wealthfront, Betterment, and SoFi offer automated portfolio management based on risk tolerance and investment goals, making them ideal for novice investors. They rebalance portfolios and adjust investments as needed, while commission-free brokerages like Charles Schwab and Fidelity provide more control over investments without transaction fees.
The Rule of 72 isn't just for forecasting investment growth; it can also illustrate the impact of inflation. For example, if inflation is at 3%, $100,000 would halve in value to $50,000 in 24 years. If inflation doubles to 6%, the same devaluation would occur in just 12 years.
This rule serves as a quick gauge for investment doubling and understanding the potential impact of inflation on your finances. It's a valuable tool in financial planning, allowing individuals to make more informed investment decisions.
Now, onto the breakdown of the concepts in the article:
- Rule of 72: Estimation tool for investment doubling based on the annual rate of return.
- Compound Interest: Earning interest on both the principal amount and accumulated interest.
- Mutual Funds and Index Funds: Investment vehicles providing diversification by pooling money from multiple investors to invest in a range of assets.
- Robo-Advisors: Automated investment platforms like Wealthfront and Betterment that manage portfolios based on individual preferences.
- Brokerages: Platforms like Charles Schwab and Fidelity that facilitate trading and investment transactions.
- Inflation: The decrease in purchasing power over time due to a rise in the general price level.
- Financial Tools: Rule of 72 as a tool for investment estimation and understanding the impact of inflation.
Understanding these concepts helps navigate the complexities of investing and aids in making informed financial decisions.
