The Rule of 72 is a straightforward
calculation used by many in the finance industry to estimate how long it will
take your money to double, based on the rate of return you earn on it. To use
it, simply divide 72 by the rate of return you expect to earn on your
investment. The result is an estimate of the number of years until that money
will be twice the size of when you started with it.
While not perfect, it is math that
many people are able to actually do in their heads, particularly with the
typical rates of returns found in investing. For instance, if you expect to
earn 9% annual returns on your money, the Rule of 72 would indicate it would
take around eight years for your money to double (72 / 9 = 8). In reality, it
would take just over eight years for your money to double -- around 8.04
years, to be exact -- making the Rule of 72 a close-enough estimate to at least
hold a discussion.
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How to put the Rule of 72 to use for you?
Once you know how long it takes your
money to double, you can use that to figure out how many times your invested
money can potentially double until you need to spend it. For instance, say
you're saving for retirement and you expect to retire in around 24 years. If
you earn 9% annual returns on your money, the Rule of 72 would estimate that
your money would double three times before you need to tap it to cover your
costs: 72 / 9 = 8 years to double, 24 / 8 = 3 doubling periods.
