Want to double your investment money? Follow the rule of 72. It’s a quick and convenient shortcut to estimate how long an investment you own with a consistent return will take to double in value, explains Stuart Robertson, CEO and president of ShareBuilder 401k.
The formula: Divide the number 72 by the return you expect to earn on your investments each year. Example: If your rate of return is 8%, it would take nine years to double your money (72 divided by 8). A 4% return would double your investment in 14 years (72 divided by 4). In general, the stock market has generated over 10% annually over time through all the ups and downs, and bonds have ranged generally between 3% and 6%.
The rule of 72 works with almost any investment that is expected to generate returns over time—savings accounts, CDs, mutual funds, ETFs, stocks and bonds. You can use the rule of 72 to help you set investment goals…compare different investments…and perhaps most important, evaluate how you are building wealth and determining if you need to make adjustments in asset categories and/or contribute more or less money to maximize the power of compounding and reach your goals.
Compounding is the reason your money grows so quickly under the rule of 72. As an investment grows, you don’t just earn gains on your original principal. You also earn gains on the accumulated gains incurred from prior years. Warren Buffett described compounding as “being at the top of a very large hill with…a snowball and getting it rolling downhill.”
When compounded, even modest annual returns can turn into staggering wealth. Example: Over the past 50 years, the S&P 500 has returned 12.4% annually (when dividends are reinvested). At that rate, your money doubled every 5.8 years. So if you invested $10,000 in an index fund in 1975 and never looked at it through all the market ups and downs, it would have doubled nearly nine times and grown to about $5 million today.
Here’s how you can use the rule of 72 for your personal-finance estimates…
Savers can see whether they are on track to retire or need to save more aggressively or work a few years longer. Example: You are 47 and estimate that you need $1.6 million to stop working. You currently have $400,000 in retirement accounts and expect a 7% annualized return on your portfolio. It will take about 21 years—a projected retirement age of 68—for your investment to double in value twice over. But you’ll want to consider how much you are contributing each year in addition to your current holdings, as that may get you there faster.
Retirees can estimate the long-term effect of inflation on their wealth. Example: You have $100,000 and expect a long-term inflation rate of 4%. If you don’t invest and grow your money, you’d lose half your purchasing power—$50,000—in 18 years.
Credit card users can calculate how quickly their revolving debt will double in size if the balance isn’t paid down. Example: You have a credit card balance of $3,000 at a 25% annual percentage rate (APR). Within just 2.9 years, your debt will grow to $6,000.
The rule of 72 doesn’t give investors the full performance picture. That’s because it focuses on nominal returns—the amount of money generated by an investment before factoring in drags on performance, such as taxes, trading costs and investment fees.
It is not mathematically precise. The actual logarithmic equation to track continuous compounding interest rates is more complex than just dividing by 72. In general, the rule of 72 works best for rates of return between 4% and 10%. Beyond those parameters, and taking into account continuing and compounding interest, the margin of error becomes significant enough that you’ll want a more accurate answer. To that end, use 69.3 in your equation instead of 72.
