The Rule of 72 estimates how long an interest-earning investment will take to double, given a fixed annual interest rate. The principle illustrates the power of compound interest over time. It can help rental property owners estimate the long-term financial impact of their real estate investment.
How the Rule of 72 works
The Rule of 72 offers a formula that allows you to estimate the years it will take for your investment to double in value. To use the rule, you divide 72 by the annual interest rate or rate of return on your investment. This calculation results in the number of years it will take for your investment to double.
Years it will take to double your investment = 72 / Annual Rate of Return
When you use this formula, the interest rate should be expressed as a number (5), not as a decimal out of 1 (0.05).
Let’s use a dollar to illustrate how the Rule of 72 works. If $1 is $1 invested at an annual fixed interest rate of 10% would take 7.2 years to become $2. We can apply this calculation to several different interest rates as follows:
- 72 / 6%= 12 years
- 72 / 8%= 9 years
- 72 / 10% = 7.2 years
In this way, we can estimate the number of years that will pass before the investment doubles. Understanding that the Rule of 72 is only an estimate is critical. The full-length equation for compounding interest is very complicated. Thankfully, the Rule of 72 gives you a way to estimate without needing complex calculations.
Rule of 72 limitations
The Rule of 72 has several limitations that rental property owners need to know. The accuracy of the Rule of 72 will vary depending on the interest rate included in the calculation. The Rule of 72 is more accurate when used with a lower rate of return or interest rate. It becomes less accurate as the interest rate increases.
The Rule of 72 is best used when the rate of return is between 6-10%. If the interest rate exceeds 15%, the Rule of 72 will no longer provide an accurate estimate. You can account for a higher interest rate and increase the accuracy of the Rule by adding or subtracting one from 72 for every 3 points the interest is below or above 8 percent.
It’s also important to understand that the Rule of 72 can only be applied to investments with compound interest, not simple interest. Compound interest occurs when earned interest is added to the principal. In this case, you can earn interest on interest previously earned. In contrast, simple in is only calculated based on the principal.
Ultimately, the Rule of 72 only provides an estimate, and rental property owners should consider other financial metrics when they make investment decisions.
What is the Rule of 69.3, and how is it different from the Rule of 72?
The Rule of 69.3 is used the same way as the Rule of 72, except it provides a slightly more accurate estimate. In most cases, the Rule of 72 is preferred because it is more easily divisible. However, if you’re looking for a fine-tuned estimate, you may choose to use 69.3 instead of 72. For the most accurate calculations, use an online compound interest calculator.
How does the Rule of 72 apply to real estate?
The Rule of 72 is best used as an estimating tool in evaluating potential investment properties. You can also use it to estimate the return on your investment for your current rental property.
For example, suppose you have a real estate investment property valued at $100,000, and that property has an 8% annual return. In that case, you can estimate that your initial investment will take nine years to reach $200,000.
How to calculate the rate of return for real estate investments
To use the Rule of 72, you’ll need to calculate the rate of return for your investment property. You can use this simple formula to estimate your rate of return:
Rate of Return = (Gain from Investment – Cost of Investment) / Cost of Investment
Your gains will include any revenue from your investment property, including rental income and equity. Your investment costs will include mortgage payments, maintenance, insurance, property management, and other expenses.
Using the Rule of 72 to evaluate real estate investments
Why is it helpful for rental property owners to understand when their investment will double? The Rule of 72 can help show you which properties or assets can quickly grow your money.
If you already own an investment property, the Rule of 72 can help you plan for the growth of your existing investments. This is particularly helpful as you prepare for capital improvements. These estimates can also play a critical role in helping you plan for retirement.
Use the Rule of 72 to evaluate your current rental property
If you currently own a real estate investment, you can use Rule 72 to make financial estimates. You’ll need to know the current rate of return on your rental property. Once you understand your rate of return, you can estimate how much your investment has grown over the time you have owned the property. The Rule of 72 can tell you if your investment has already doubled. You can also calculate how the number of years before your investment doubles for the first or second time. Understanding how quickly your money will grow can create a better financial picture and help you understand your risk tolerance.
Use the Rule of 72 to evaluate risk
When you weigh the risks of investments, it’s helpful to compare risks against specific time horizons. The Rule of 72 allows you to compare a low-risk property with a return of 3% against a higher-risk investment property with a 14% return. Using the Rule of 72 calculation, you can estimate how often your investment will double. With this information, you can evaluate the risk and potential reward.
The right amount of risk will depend on your tolerance. Generally, individuals closer to retirement prefer lower-risk investments. In contrast, those with a longer time horizon may be comfortable with higher-risk opportunities.
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The Rule of 72 is a fantastic tool for estimating the time it takes for an investment to double based on a fixed annual interest rate. It's a powerful illustration of compound interest's impact over time, particularly useful for rental property owners evaluating their real estate investments.
This rule is straightforward: you divide 72 by the annual interest rate or rate of return on your investment to estimate the years required for your investment to double. For instance, if the interest rate is 10%, dividing 72 by 10 gives you approximately 7.2 years for your investment to double.
The formula, ( \text{Years to Double} = \frac{72}{\text{Annual Rate of Return}} ), provides quick estimations when the interest rate is expressed as a whole number (like 5 for 5% interest) rather than a decimal (0.05 for 5%).
However, the Rule of 72 has its limitations. It's more accurate within the 6-10% range of interest rates. Accuracy diminishes as rates deviate from this range, especially when they surpass 15%. To refine estimates outside this range, you can adjust by adding or subtracting one from 72 for every 3 points the interest is below or above 8 percent.
This rule works solely with compound interest, where interest accrues on previously earned interest. It's crucial to note that it doesn't apply to simple interest, which is calculated solely based on the principal.
Now, about the Rule of 69.3: It's akin to the Rule of 72 but provides a slightly more accurate estimate. While the Rule of 72 is preferred due to its ease of use, the Rule of 69.3 can offer more precision. For precise calculations, online compound interest calculators might be your best bet.
Applying the Rule of 72 to real estate, it becomes an excellent tool for estimating the growth of investments. For instance, for a property with an 8% annual return, you can estimate it'll take approximately nine years for your investment to double from its original value.
To compute the rate of return for real estate investments, use the formula: ( \text{Rate of Return} = \frac{\text{Gain from Investment} - \text{Cost of Investment}}{\text{Cost of Investment}} ). This takes into account revenues (like rental income and equity) against expenses (mortgage payments, maintenance, insurance, etc.).
Understanding when your investment will double aids in financial planning and risk assessment. It allows comparisons between low-risk and high-risk investments, helping evaluate the potential rewards against associated risks.
And if you're seeking assistance managing rental properties, services like Belong offer support to optimize your investment by guaranteeing monthly rental income, making returns consistent and easy to calculate. Their expertise can contribute significantly to your financial freedom without the hassle of day-to-day management.
