What Is the Rule of 72 and How Does It Work?

The Rule of 72 provides a straightforward mathematical shortcut to estimate the time it takes for an investment or any value to double. This simple calculation offers a quick approximation of growth periods given a fixed annual rate of return. Individuals and financial planners frequently utilize this rule for rapid mental calculations and preliminary financial assessments.

Understanding the Concept

The core of the Rule of 72 lies in a simple division: to find the approximate number of years it takes for an amount to double, one divides 72 by the annual interest rate. It is important to express the annual interest rate as a whole number, not a decimal, for this calculation. For example, if an investment earns an 8% annual return, the calculation would be 72 divided by 8. Performing this calculation yields 9, indicating that it would take approximately 9 years for the investment to double in value at an 8% annual growth rate.

Practical Applications

The Rule of 72 offers insights across various financial scenarios, making it applicable beyond just investment growth. For instance, in personal investing, it can estimate how long it might take for a savings account balance or a retirement fund to double at its current average rate of return. An investment growing at 6% annually would roughly double in 12 years.

This rule also helps in understanding the impact of inflation on purchasing power. If inflation averages 3% per year, the Rule of 72 suggests that the purchasing power of money would halve in approximately 24 years. Conversely, for debt, especially credit card debt with high compounding interest, the rule illustrates how quickly the principal can double if only minimum payments are made. A credit card with an 18% annual interest rate could see the debt double in roughly 4 years if no principal is paid down.

Important Considerations for Use

The Rule of 72 serves as an estimation tool and does not provide an exact calculation. Its accuracy is highest for interest rates between 6% and 10%, becoming less precise at very low or very high rates. The rule assumes a constant annual interest rate throughout the period, which rarely occurs in real-world investment environments. It also primarily functions best with annual compounding, and its accuracy may decrease with more frequent compounding periods like monthly or daily. The rule does not account for external factors that impact actual returns, such as taxes on investment gains, management fees, or any additional contributions or withdrawals.