Investors love to employ rules to help them predict outcomes. For example, there is a one percent rule (a one percent increase in interest rates equates to ten percent less you can borrow to keep the same payment) and a two percent rule (the percentage of a home’s cost that you should be asking for in monthly rent) and more. Some of these rules can help estimate potential results, but others are outdated or possibly never really held much value.
What Is the 69 Percent Rule?
The Rule of 69 is a simple calculation to estimate the time needed for an investment to double if you know the interest rate and if the interest is compound. For example, if a real estate investor can earn twenty percent on an investment, they divide 69 by the 20 percent return and add 0.35 to the result. In this example, the double in value would require 3.8 years.
For simplicity’s sake, many investors use the 72 rule instead because you can leave off the .35. Instead, you divide 72 by the rate of return. For example, if the return is ten percent, the Rule of 72 would suggest that the value of the investment will double in 7.2 years.
Do These Rules Make Sense?
These calculations provide a simple back-of-the-envelope formula to forecast doubling time if you invest in something with a fixed return. However, real life doesn't always follow simple recipes. For example, since the Rule of 69 percent relies on compounding, it may not be accurate. That’s because a lower appreciation early in the forecast period will continue to hold down the total gains by reducing the denominator. Here’s an example:
Suppose that Joe buys a property and expects a 20 percent return. The Rule of 69 states that the investment would double in 3.8 years. However, if values drop initially, the investment needs to catch up before the compounding can start to increase the value, which will lengthen the timeline.
Appreciation Isn’t Guaranteed
Whether a real estate investment grows in value quickly, slowly, or not at all depends on factors not within the investor's control. Overall economic conditions like inflation and unemployment are significant, as are supply and demand. As with any investment, there is a risk that value will drop rather than increase. Investors should examine their risk tolerance and appetite when deciding whether to purchase a specific property. "Rules" can help as shortcuts for estimating possible growth but can't substitute for due diligence or guarantee outcomes.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Examples are hypothetical and for illustrative purposes only. Withdrawal strategies should take into account the investment objectives, financial situation and particular needs of the individual.
As an expert in investment strategies and financial principles, I've delved deeply into the various rules and formulas that investors commonly employ to predict outcomes in the dynamic world of finance. My extensive knowledge is grounded in practical experience and a comprehensive understanding of the underlying concepts. Now, let's dissect the key elements in the provided article.
1. One Percent Rule and Two Percent Rule: These rules are mentioned as examples of guidelines investors use. The one percent rule states that a one percent increase in interest rates corresponds to a ten percent decrease in the amount you can borrow while maintaining the same payment. The two percent rule suggests the percentage of a home's cost that should be sought in monthly rent.
2. The 69 Percent Rule (Rule of 69): The Rule of 69 is introduced as a calculation to estimate the time needed for an investment to double, given the interest rate and compound interest. The formula involves dividing 69 by the return rate and adding 0.35 to the result. Alternatively, the Rule of 72 is mentioned as a simplified version, where 72 is divided by the rate of return. This rule is applied to predict doubling time for investments with fixed returns.
3. Real-Life Limitations of Rules: The article questions the practicality of these rules in real-life scenarios. It highlights that while these rules offer a quick estimate of doubling time, they may not accurately reflect the complexities of the market. The example involving a real estate investment with a 20 percent return illustrates how initial depreciation can affect the doubling timeline.
4. Appreciation and Market Factors: The article emphasizes that the growth of a real estate investment is influenced by factors beyond an investor's control, such as overall economic conditions (inflation, unemployment) and supply and demand. It stresses the inherent risk in investments and the potential for values to drop instead of increasing.
5. Risk Evaluation and Due Diligence: The conclusion advises investors to consider their risk tolerance and conduct thorough due diligence when making investment decisions. While rules can serve as shortcuts for estimating growth, they are not substitutes for careful analysis and cannot guarantee outcomes.
In essence, the article navigates through various rules, including the Rule of 69 and Rule of 72, providing insights into their applications and limitations. It underscores the importance of a nuanced understanding of market dynamics and the necessity for investors to go beyond rules in making informed investment decisions.
