The Rule of 72 is a simple and widely used financial formula used to estimate the number of years it takes for an investment to double in value, given a fixed annual rate of return. It is a quick and handy tool for understanding the impact of compound interest or investment growth over time.
The Rule of 72 formula is:
Number of Years to Double = 72 / Annual Rate of Return
In this formula:
- "Number of Years to Double" represents the approximate time it will take for an investment to double in value.
- "Annual Rate of Return" refers to the expected or historical annual percentage rate of return on the investment.
Keep in mind that the Rule of 72 is an approximation, and it works best for annual rates of return ranging from 6% to 10%. The accuracy of the rule decreases for significantly higher or lower rates of return.
Let's look at an example: If you have an investment with an expected annual return of 8%, the Rule of 72 tells you that it would take approximately 9 years (72 / 8) for that investment to double in value.
For instance, if you initially invested $10,000, it would take around 9 years for the investment to grow to about $20,000, assuming an 8% annual rate of return and no additional contributions.
The Rule of 72 is often used as a quick mental calculation to estimate the time it takes for investments or savings to grow significantly. However, for precise calculations, especially when considering other factors like taxes, fees, or variable rates of return, it is better to use more sophisticated financial tools and equations.