The Rule of 72 or When You Will Double Your Money
One of the most important factors to consider before making any investment decision is determining the rate of return on your investment. The higher the rate the better compounding effect works for the growth of an investment. Whether your financial portfolio comprises just of a savings account at your local bank or a series of highly leveraged assets, the compounding effect significantly improves your rate of return.
To put it in perspective, simple interest only pays interest on the principal. With compound interest, the return on your first investment is automatically reinvested. In other words, you get interest on interest. But how fast does your money grow? The simplest approach to figure it out is to apply the "Rule of 72." Simply saying, the "Rule of 72" tells you how long it will take for your money to double if you invest on a compound interest basis. To find the answer, divide 72 by the interest rate your investment is generating.
For example, if you invest $10,000 at 10% compound interest, the "Rule of 72" predicts that you will have $20,000 in 7.2 years. The time it takes for your money to double is calculated by dividing 72 by 10%. The "Rule of 72" is a rule of thumb that provides approximate results. It is most accurate for hypothetical rates ranging from 5% to 20%.
While compound interest is an investor's best friend, inflation is one of his worst adversaries. The "Rule of 72" may also demonstrate the devastation that inflation can do to your finances. Assume you decide not to invest your $10,000 and instead stash it beneath your mattress. Assuming a 5% inflation rate, your $10,000 will have lost half its value in 14.4 years.
The real rate of return (nominal rate of return minus the rate inflation) determines how rapidly your investment's value will rise. If you earn 10% on an investment but inflation is 5%, your real rate of return is 5%. In this case, it will take 14.4 years for your money to double in value.
The "Rule of 72" is a simple formula for calculating the value of compound interest over time. By considering the actual rate of return (nominal interest minus the rate of inflation), you may determine how quickly a given investment will double the value of your money. The "Rule of 72" is just a mathematical concept and therefore the principal and yield of securities may fluctuate with market circumstances, so when sold, the shares may be worth more or less than their initial value. The "Rule of 72" does not account for income or taxation and it is assumed that interest is compounded once a year, therefore, in real-life outcomes will vary. If you have more questions about the “Rule of 72” or other investment-related topics, Contact One of Our Advisors for a free consultation.
The material on this page reflects PG Capital's professional opinions as of today and is subject to change. The information presented here has not taken into account any particular investor's investment goals or needs, and investors should not base their investment decisions entirely on this material. Past performance is not a guarantee of future results. All investments involve some amount of risk, and investors have different time horizons, goals, and risk tolerances, so consult with your PG Capital Financial Advisor before proceeding.