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 Some of these rules can help estimate potential results, but others are outdated or possibly never really held much value.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 a seasoned expert in financial analysis and investment strategies, I've navigated the intricate landscape of rules and formulas that investors commonly employ to predict outcomes. My extensive experience in the field, backed by a solid foundation in finance and investment principles, positions me to shed light on the concepts underpinning the article in question.
Now, let's delve into the concepts introduced in the article:
1. One Percent Rule and Two Percent Rule:
- One Percent Rule: States that a one percent increase in interest rates results in a ten percent decrease in the amount one can borrow to maintain the same payment.
- Two Percent Rule: Suggests that the monthly rent for a home should be two percent of the home's cost.
2. The Rule of 69 (or Rule of 72):
- Rule of 69: A calculation to estimate the time required for an investment to double, considering the interest rate and compounding. The formula involves dividing 69 by the rate of return and adding 0.35 to the result.
- Rule of 72: Similar to the Rule of 69 but simplifies the calculation by directly dividing 72 by the rate of return.
3. Realism of These Rules:
- These rules provide a quick, back-of-the-envelope method to forecast doubling time for an investment with a fixed return.
- However, real-life scenarios may not always conform to these simplified rules due to factors like fluctuations in market conditions.
4. Factors Affecting Investment Growth:
- Compounding: The Rule of 69 relies on compounding, and if there's lower appreciation early in the forecast period, it can impact the accuracy of the rule.
- Economic Conditions: Overall economic factors such as inflation, unemployment, and supply and demand play a significant role in investment outcomes.
- Risk: There is always a risk that the value of an investment may drop rather than increase, emphasizing the importance of assessing risk tolerance.
5. Caution on Reliance on Rules:
- While rules serve as shortcuts for estimating growth, they cannot replace due diligence or guarantee investment outcomes.
- Investors should be mindful of economic uncertainties and factors beyond their control.
6. General Disclaimer:
- The article concludes with a disclaimer emphasizing that the provided information is for general information and educational purposes only.
- It highlights that examples are hypothetical and should not be the sole basis for investment decisions.
In essence, the article underscores the need for investors to balance the simplicity of rules with the complexities of real-world financial dynamics and exercise due diligence in their decision-making process.
