Smart money moves
What is the Rule of 72?
In the world of finance, there are so many formulas and equations and acronyms it can be very intimidating for regular people who smartly, spend their time living their lives rather than obsessing over this stuff.
That is why I love the Rule of 72 so much, you don’t need a spreadsheet or any knowledge of finance to understand it. The rule of 72 tells you how long it will take for your investment to double. The only variable you need is an estimated rate of return on your investments. You divide 72 by your annual rate of return, and that is how many years it will take to double your money.
For example, let’s say I have $10,000 today and I invest in an asset that will return 6% per year. I know my $10,000 will double to $20,000 in about 12 (72÷6=12) years. You can imagine how this might be a really useful rule of thumb for anyone trying to figure out how their retirement funds will be looking 10 years out.
“The rule of 72 tells you how long it will take for your investment to double.”
Applications of The Rule of 72
One obvious way to use the Rule of 72 is comparing how long we might expect it will take for different investments to double in value. Let’s compare the length of time to double an initial investment $10,000 when investing in a U.S. 3 Year Treasury Note and Vanguards S&P 500 Index fund (which I am personally invested in).
As of the date of this post:
- the U.S 3 Year Treasury Note had a yield of 2.765%
- The average annualized total return for the S&P 500 index over the past 90 years is 9.8% (which I will use as my expected return for this analysis).
Length of Time we expect $10,000 to double into $20,000
- U.S 3 Year Treasury Note: 26.04 years
- S&P 500 Index Fund: 7.35 years
If the S&P continues, near its historical average you could expect to double your investment every 7 years and 4 months. Obviously, there is a lot more volatility and risk in the market compared to U.S Treasuries but it would take a whopping 26 years to double your money investing in Treasuries.
Now consider the fact that this does not even take inflation into account! $20,000 will be worth a hell of a lot less in 26 years then it is today. Let’s rerun these numbers assuming a 2% average rate of inflation.
Length of Time we expect $10,000 to double into $20,000 in “real” terms, adjusted for inflation.
- U.S 3 Year Treasury Note: 94.11 years
- S&P 500 Index Fund: 9.23 years
accounting for inflation it would take the S&P over 9 years to double its value while it would take the 3-Year Treasury over 94 Years! The old adage is true “inflation is a bond’s worst enemy”. Speaking of inflation that brings me to the final topic I want to discuss in regards to the Rule of 72.
Measuring the Impact of Inflation
The rule of 72 can not only tell us how long it will take for your investments to double, but it will also tell you how long it will take for any cash you have in a chequing account or under your mattress to lose half its value. Its rule of 72 works the same way for measuring the impacts of inflation 72÷” rate of inflation”.
Again, assuming a 2% rate of inflation it would take 36 years (72÷2) for your $10,000 to lose half its value if you hold it in a chequing account. If inflation rose to 6% your $10,000 would lose half its value in just 12 years (72÷6).
So there you have it, a simple and useful calculation that anybody can use to project the growth of your money in both nominal and real (adjusted for inflation) terms.
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This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.