How to Understand the Rule of 72. Does the very thought of making financial calculations make you shudder? Don't worry, here I will show you the Rule of 72, a simple mathematical formula that allows you to determine how long it will take an investment to double in value if it earns a specific rate of return--enabling you to evaluate whether or not an investment fits your objectives--the only equation you may need to know when it comes to making investment projections.
The rule states that the rate of return on an investment is multiplied by whatever number is needed in order to equal 72. For example, if your mutual fund has averaged 9 percent growth over time, then 9 X 8 = 72. Therefore it will take 8 years for your money to double in this fund (assuming that it continues to grow as it has in the past, of course.)
Apply this rule to almost any investment to see whether or not it is appropriate for you. If a CD is paying 3 percent, then The Rule of 72 mandates that it will double in value in 24 years. Therefore if you need your money to double more often than that, then you know that a CD is not an appropriate investment.
Use the Rule of 72 to help you determine how much you will have at the end of a given period of time. For example, if you have $10,000 to invest for 30 years, earning 6 percent interest, then 72/6 = 12. Therefore, you will have $20,000 in 12 years, $40,000 in 24 years and $80,000 in 36 years. So in 30 years, you will have perhaps around $65,000, give or take.
Of course, mathematical rate of return is not the only factor to consider when analyzing investment returns. Risk must be taken into account as well, and the higher the rate of return, the greater the amount of risk you take. Consult your financial advisor for more information.
- Of course, mathematical rate of return is not the only factor to consider when analyzing investment returns. Risk must be taken into account as well, and the higher the rate of return, the greater the amount of risk you take. Consult your financial advisor for more information.
I am a Certified Financial Planner with about 13 years of experience in the financial industry. I have worked as a stockbroker, income tax preparer, financial planner and loan officer. I am also involved in a venture capital enterprise in the oil and gas sector.