Have you heard of the “Rule of 72”?
It’s actually just a simple mathematical tool used to compute the number of years it will take to grow your money by 100%. Simply speaking, the “Rule of 72” tells you approximately when you’ll be able to double your money.
Great tool, isn’t it?
Read on to see examples how we can use the “Rule of 72” to predict when we’ll be able to grow our money by 100%, effectively doubling our investment money.
What is the Rule of 72?
Yes, the “Rule of 72” is a math formula, but don’t be intimidated by it because it’s just pretty straightforward. Here’s how to use it:
Divide the number “72” by the interest rate, and the resulting number is approximately the number of years you’ll have to wait before your money doubles.
Easy, right? The mathematical formula is:
72 / r = Number of Years it will take to Double your Money
* r = rate of return or interest rate of the investment asset
Take note that when dividing by r, you must only use the number, not the actual percentage. For example, if the interest rate you’re using is 8%, divide 72 by the number 8, not the percentage (8%).
The resulting number is the approximate number of years you’ll be able to grow your money by 100%. Do note, though, that it is not an exact science. It merely shows an approximation, not the exact number of years and months it will take to double your money.
Still, the results are pretty close to the actual number, as seen in our table below which compares the resulting number of years using the “Rule of 72” and the actual number of years it will take to double your money given a certain percentage return.
How long it takes to double your money
Looking at the following table, if you’re invested in an asset that gives you 1% interest rate per year, it will take 72 years before you can double your money. That certainly is a long time to wait!
|Interest Rate||Approximate No. of Years it Takes to Double your Money (using Rule of 72)||Actual No. of Years it Takes to Double your Money|
Thus, the way to shorten this period is to look for investments that can potentially earn you higher returns. If, for example, you were able find an investment that pays 5% interest per year, it will take around 14.4 years to grow your capital by 100%.
See the drastic difference? With just 1% interest rate, you’ll be able to double your money in 72 years — but this goes down to just 14.4 years if you’re able to invest in an asset with a 5% return every year. That, of course, is the challenge. You’ll have to look for an investment that can sustainably pay you the desired interest rate year after year after year.
Let’s see more practical applications of this useful tool, the “Rule of 72”.
Example #1: When will I double my money?
Example 1. You invested P20,000 in a Mutual Fund that, historically, has been providing returns of 8% per year.
Of course, there is no assurance that this rate of return will continue in the future. But assuming this 8% annual return is maintained, how many years will it take before your P20,000 earns you another P20,000, or in other words, when will you be able to double your investment?
Answer: To solve this, simply replace r in the formula above with 8. Take note that we’ll use the number 8 and not 8%. Thus:
72 / 8 = 9 years
This means you will have to wait nine (9) years to double your money in that mutual fund — assuming of course the 8% rate of return is sustained year after year after year.
Example #2: Where to invest so I can double my money in 4 years?
Example 2. Now, let’s assume that your goal is to earn 100% return or to double your money in 4 years. Where should you put your cash to achieve this goal?
Answer: We’ll know the answer to that question if we first find out what our required r or rate of return is. And, yes, our nifty “Rule of 72” tool can help us with that.
To solve this, simply re-arrange the “Rule of 72” formula to compute r. The formula, then, to solve for r is:
72 / No. of Years to Double your Money = r (interest rate or rate of return)
Which means if you want to double your money in 4 years, the required r or rate of return is:
72 / 4 years = 18%
Conclusion: You need to invest your money in an investment that can give you 18% rate of return annually. Which types of investments can achieve this return?
The assumption, of course, is that the 18% return is sustained year after year; otherwise, your money won’t double in 4 years. Any return below 18% will lengthen the period that you’ll be able to double your money.
Do note as well that the higher the potential return of an investment, the higher the risk of loss associated with it! We’ll see this in the next example.
Example #3: Which of these investments is better?
Example 3. This time, let’s assume you’re considering to place your money in either of two investments. You are introduced to two options: one that pays 6% interest per year, while the other gives 8% return per year. Which one is the better investment?
At first glance, it seems like it’s an easy choice. If you want to double your money faster, you should choose the higher-yielding instrument, that is, the 8% investment.
But you must also know that given the higher return, the higher the risk is with that asset. Which means if you chose the 8% instrument, it could be riskier, meaning, there is a higher likelihood that you can lose money.
The Rule of 72 can help you determine the difference in number of years to double your money given the two options, and you can use this to evaluate if you are willing to trade longer waiting period for potentially lower investment risk.
For example, looking at our table above, with an investment paying 6% return, your money can double in 12 years.
With the 8% asset, meanwhile, you double your investment in a shorter period, that is, 9 years.
The difference between these two periods is 3 years (12 minus 9).
The question now is: Are you willing to wait an additional 3 years so you can double your money, in exchange for investing in a less risky asset?
If yes, meaning you’re willing to wait 3 years longer in exchange for a lower likelihood of capital loss, then go for the investment with the lower rate of return (which has relatively lower risk of loss). But if you like the possibility of doubling your money faster, opt for the higher return investment but be ready to bear a higher possibility of capital loss too because of higher risk.
As you can see, this dilemma is helped solved by the Rule of 72.
Example #4: How long before my credit card debt equals my interest payments?
Example 4. Finally, you can also use the Rule of 72 to assist you in managing your credit card debt or other loans. Let’s assume you have a credit card debt that charges 18% per year (I’m sure some of you are faced with this high interest problem!).
Cashflow issues prevent you from paying the principal so you decide instead to only pay the interest charge every time.
Using the Rule of 72, it tells you that in four (4) years, you would have already paid total interest that is already equal to your total principal debt.
Wait, what?!! With an 18% interest charge, your total interest payments would have already doubled in 4 years. This means you’ve actually paid total interest equal to your total credit card debt, and yet your principal debt is still unpaid. Isn’t that alarming?
To compute, using the Rule of 72:
72 / 18 = 4 years
Again, given a credit card interest charge of 18% per year, in just 4 years time, you actually would have paid a total amount of interest equal to the actual principal! And yet, you actually haven’t paid the principal because you were merely just paying the monthly interest charge. That’s bad!
Now you see that the Rule of 72 can be useful not just in assisting you in your investments, but in helping you manage debt and personal finances as well.
So thank you, Rule of 72!
P.S. Some variations of the double-your-money formula are the Rule of 69, Rule of 69.3 and Rule of 70. These are better approximations of the actual number when you’ll double your money, but the Rule of 72 is easier to use because 72 is divisible by 1, 2, 3, 6, 8, 9, 12.
Read these other awesome posts to increase your investment knowledge!
- Best Mutual Funds in the Philippines
- Best UITF (Unit Investment Trust Funds) in the Philippines
- How to Invest in Stocks in the Philippines
- How to Invest in PERA (Personal Equity Retirement Account)