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What is the Rule of 72?
The Rule of 72 is a simple financial formula used to estimate how long it will take for an investment to double in value at a fixed annual rate of return.
Key takeaway: Divide 72 by the annual rate of return to determine how many years are needed for your investment to double.
Definition
The Rule of 72 estimates the number of years required for a value or investment to double, based on a fixed annual rate of compound interest.
Why It Matters
The Rule of 72 offers a quick, intuitive way for investors to understand the power of compounding and evaluate different investment options. It simplifies financial decision-making and highlights how small rate differences impact long-term wealth growth.
Key Features
- Quick estimation tool for doubling time.
- Applies to interest rates, inflation, and GDP growth.
- Based on compound interest mathematics.
- Best suited for rates between 6% and 10%.
- Commonly used in finance, investing, and economics.
How It Works
- Identify the Rate of Return: Determine your expected annual growth rate.
- Apply the Formula: 72 ÷ rate of return = years to double.
- Interpret the Result: The output gives an approximate doubling time.
- Compare Scenarios: Use it to compare investments with different returns.
- Adjust for Taxes and Inflation: Real returns determine actual growth.
Types
- Investment Growth: Estimate portfolio or savings growth.
- Inflation Impact: Measure how inflation erodes purchasing power.
- Economic Growth: Predict GDP doubling time.
Comparison Table
| Feature or Aspect | Rule of 72 | Rule of 70 |
|---|---|---|
| Divisor | 72 | 70 |
| Accuracy Range | 6–10% | 1–15% |
| Focus | Financial investments | Economic growth |
| Use Case | Interest and returns | GDP and population |
Examples
- Example 1: Investment at 8% annual return → 72 ÷ 8 = 9 years to double.
- Example 2: Inflation at 3% → 72 ÷ 3 = 24 years for prices to double.
- Example 3: Savings earning 6% → 72 ÷ 6 = 12 years to double.
Benefits and Challenges
Benefits
- Fast mental math for investors.
- Easy comparison of investment growth.
- Demonstrates compounding power clearly.
- Useful for both inflation and return estimates.
Challenges
- Assumes a constant rate of return.
- Less accurate at very high or low rates.
- Doesn’t account for taxes or compounding frequency.
Related Concepts
- Compound Interest: Growth of principal and accumulated interest.
- Time Value of Money: Value of money changes over time.
- Exponential Growth: Continuous rate-based expansion.
FAQ
Why is 72 used in the formula?
The number 72 divides evenly by many small integers (2, 3, 4, 6, 8, 9), making calculations simple and intuitive.
How accurate is the Rule of 72?
It’s generally accurate for rates between 6% and 10%; deviations increase outside that range.
Can it apply to inflation or debt growth?
Yes — it works for any rate of change, including inflation and compounding debt.
What’s the difference between the Rule of 70 and 72?
The Rule of 72 is favored in finance for convenience, while 70 is used more in economics.
Sources and Further Reading
- Investopedia: https://www.investopedia.com/terms/r/ruleof72.asp
- Federal Reserve Education: Understanding Compound Interest
- CFA Institute: Principles of Compounding and Time Value
Quick Reference
- Doubling Time: Time for value to double at a constant rate.
- Growth Rate: Annual increase percentage.
- Compound Interest: Earnings on both principal and interest.
