Demystify investing with the Rule of 72. Learn how to use this straightforward formula to compare potential returns across investments and understand the impact of compound interest, inflation and investment costs.
Navigating the complex world of investing can feel overwhelming, especially when it seems like you need a math degree to understand your potential returns. But what if there was a straightforward formula to demystify the investment process?
Enter the Rule of 72. This simple yet powerful tool can help you quickly gauge how long it may take for your investments to double. Let’s look at its utility and how it can be a game-changer for financial planning.
Decoding the Rule of 72
Simply put, the Rule of 72 offers a quick and straightforward method for investors to estimate the number of years required to double their money at a consistent rate of return.
The formula is simple. You divide 72 by your expected annual rate of return. This calculation will help you arrive at the approximate number of years it'll take for your investment to double.
Consider this example:
- 5% Rate of Return: If you're anticipating an average return of 5% on an investment, you'd divide this return into 72. This means, at a 5% rate of return, your investment would roughly double in 14.4 years.
- 7% Rate of Return: Similarly, for an average return of 7%, it would take a little over 10 years for your money to double.
Now, let’s look at those numbers in dollar figures:
| Rate of Return | 5% | 7% |
| Initial Investment | $1,000,000 | $1,000,000 |
| Year 10 | $1,628,895 | $1,967,151 |
| Year 15 | $2,078,928 | $2,759,032 |
| Year 20 | $2,653,298 | $3,869,684 |
Limitations
Importantly, there are a number of limitations when it comes to the Rule of 72.
Keep these in mind:
- Estimation Tool: While the Rule of 72 is incredibly useful, it's an estimation tool. Real-world factors, like market volatility, can affect actual doubling times.
- Consistent Returns: The rule assumes a consistent rate of return. In reality, the stock market or other investments can be unpredictable, with returns fluctuating year by year.
- Compounding: The rule is based on the principle of compounding interest. The more frequently interest is compounded, the faster your money grows.
In essence, the Rule of 72 is a valuable starting point, helping you to quickly visualize the potential of your investments. However, always consider it alongside other financial metrics and insights for a comprehensive view of your investment landscape.
The Rule of 72 is a shorthand calculation to find out how long it will take your money to double based on a given rate of return.
Benefits and Practical Uses for Investors
The Rule of 72 isn't math for the sake of math; it offers tangible benefits and can be an essential tool in an investor's arsenal.
Here's how to put it to work:
- Simplify Financial Projections: With this simple division, the Rule of 72 offers you a snapshot of potential growth over time. No need for complex financial calculators or software.
- Compare Investments: By using this rule, you can quickly compare the potential growth rates of different investments. For instance, comparing a bond yielding 4% to a stock portfolio estimated at 8% gives a clearer picture of which might double first.
- Manage Inflation: Beyond investments, the Rule of 72 can help you understand how inflation might erode your purchasing power. By dividing 72 by the average inflation rate, you can estimate how long it'll take for the cost of living to double, aiding in long-term financial planning.
- Visualize the Power of Compounding: By visualizing how quickly investments can grow, the Rule of 72 underscores the importance of compounding. It encourages you to start early, highlighting that even seemingly small rates of return can lead to significant growth over extended periods.
- Keep an Eye on Investment Costs: Using the Rule of 72 can make you more aware of the impact of fees and other costs. Even a 1% fee can substantially alter the number of years it takes for an investment to double, emphasizing the importance of minimizing unnecessary expenses.
In summary, the Rule of 72 provides a quick, practical lens through which investors can view their financial landscape, guiding decisions and reinforcing key investment principles.
With the Rule of 72, you can do a quick side-by-side comparison of potential investments.
The Rule of 72 To-Do List
Maximize your investment growth and stay ahead of inflation by putting the power of the Rule of 72 to work with this actionable checklist:
- Understand the Rule: Familiarize yourself with the formula. Remember, the number of years to double = 72 ÷ annual interest rate.
- Evaluate Current Investments: List out all your investments and write down their annual return percentages.
- Apply the Rule: Using the Rule of 72, calculate the doubling time for each of your investments.
- Compare Investment Opportunities: When considering new investment opportunities, use the Rule of 72 to estimate potential growth and compare it against other options.
- Consider Inflation: Determine the current inflation rate and use the Rule of 72 to project how long it'll take for your living expenses to double.
- Adjust for Fees and Taxes: Remember to factor in any management fees, transaction costs, and potential taxes when calculating your real rate of return.
- Periodic Review: At least once a year, revisit your investments and apply the Rule of 72 again. Adjust your portfolio if needed, based on your findings.
- Stay Updated: Continuously update yourself on prevailing market rates, economic trends, and other factors that can impact your return rate.
- Educate and Share: Discuss the Rule of 72 with family members or fellow investors. It's a valuable tool that can benefit everyone.
- Seek Expert Advice: If unsure, always consult with a financial advisor or expert to make the most of your investments and the Rule of 72.
Ultimately, the Rule of 72 is designed to simplify your investing process, while protecting you from the negative impacts of inflation and rising investment costs.
Reviewing Your Investment Portfolio or Considering a New Purchase?
Work with the experienced advisors at Comerica. We’ll help you put the Rule of 72 into action, alongside other proven investment analysis tools. Contact your Comerica Relationship Manager or contact Comerica today.
