When it comes to investing and planning for the future, it often seems difficult to determine how much money is needed to invest over a certain period of time to reach your goal and receive the desired returns of your investment.
Have you been in a situation where you want to make a financial plan for a retirement or college fund but are unsure of when to start and how much to start with? If so, you’re certainly not alone and there is a fairly simple trick to help you get started.
What is the Rule of 72?
The Rule of 72 is a simple formula commonly used by financial investors or advisors to determine how many periods it would take for a given investment to double at a specific growth or interest rate.
When creating a long-term investment plan, whether it be for a retirement or college fund, one of the most efficient ways to maintain growth is from the generation of compound interest. Generally, every fund or portfolio has a certain interest rate and when that given interest is reinvested into the fund it grows exponentially under the accumulation of its compounded interest. It is by this concept of compound interest that the rule is defined to see how long it will take for your investment to double and if the investment is worth pursuing.
How does the rule work?
To determine how long it will take for your money to grow using the rule of 72, simply divide the number 72 by the interest rate of your investment.
For example, you are preparing a college fund for your young child at an 8% rate and want to make sure you will be saving enough for him/her to receive a top tier education by the time they graduate high school. To calculate how long it will take this investment to double simply divide 72 by 8 and you will see that your initial investment will double every 9 years(72፥8=9).*
Is this rule accurate?
Although this rule is only an approximation, it is an accurate and reliable resource for both investors and advisors. For rates of return under 10%, the average difference in years between the number given by the rule of 72 and the actual number of years is 0.36 years.
This means that for investments with an interest rate under 10% the rule of 72 is accurate and reliable. As the rate of return deviates above this level, the accuracy of the rule diminishes but still provides a dependable estimation for the growth of your investment.
* This is a hypothetical example for illustrations purposes only and does not represent an actual investment