Investment and The Rule of 72 … or the Eighth Wonder of the World
Investment and The Rule of 72 outlines a basic arithmetic rule of thumb and will appeal most to those fairly new to financial planning or are less confident in financial matters.
Investment and The Rule of 72
I am often asked for some quick and simple ‘rules of thumb’ by both clients and by financial journalists who are looking for some help with financial planning articles. I often cite ‘The Rule of 72’ as a good example of one of these rules. I will detail others in future articles.
So just what is the Rule of 72?
It is a very quick and simple piece of arithmetic which gives you a fairly accurate indication of how your investments may grow depending on the level of interest or investment return they are receiving annually. In effect, it is a shortcut through lots of detailed calculations to give a fairly decent guestimate of progress towards a lump sum goal.
To do the calculation all you have to do is divide 72 by your annual investment growth rate or interest rate.
For example, if you had savings that were returning a hypothetical 7% a year, it would take just over 10 years for your investments to double in value (72/7 = 10.3).
The arithmetic also works if you’re trying to figure out what annual growth or interest rate you need to double your money in a set number of years.
For example, if you wanted to double your money in five years, you’d need a pretty huge 14.4% rate of return (72/5 = 14.4).
There are some limitations however and I would mention that the Rule of 72 is fairly accurate for growth rates that fall between 6% and 10% but the further outside this range you go, the less accurate it will be. So, I would remind you that this is just a rule of thumb but in my opinion it is still a very handy way to do some quick compound arithmetic in your head when you don’t have a financial planner or scientific calculator close by!
Another reason that I offer you this bit of simple arithmetic is that it may well help you understand the value of saving and just how much your savings can grow through the power of compound interest. You are receiving return on your original investment but also upon the interest or investment return also each year. I would mention that compound interest and The Rule of 72 has some pretty heavyweight backing too.
“Compound Interest is the eighth wonder of the world.” Albert Einstein 1878 – 1955
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