Revisiting The Rule of 72

Have you ever heard of the Rule of 72?

It’s one of those personal finance calculators that’s been around for a while, and it’s about as basic as it gets. Yet, it’s been used by some people to quickly project results for a given investment over time.

The rule is essentially a quick way to determine how long it will take you to double your money at a current rate of return. It works as follows: start with the number 72, and divide it by the rate of return of an investment over time. The result will be the number of years it will take to double your money.

For example:

Let’s say you have an investment that will earn you a total annual return of 3%.  It would then take you 24 years to double your money (72/3 = 24).  Too long? Well, jack that rate of return up to 6%, and it will then take you just 12 years to double your money.

While I consider myself to be analytical, and comfortable with complex calculations, I do like such tricks such as the rule of 72.  They allow us to quickly, on the fly, do some basic calculations. In this case, we all could have quickly divided 72 by 3 (or 6) in our minds to get the answer in just a matter of seconds.

For whatever reason, this one in particluar has struck me as being nice for those of us who gravitate toward investment growth thoughts.  It”s a quick way to think about what money could become in the future.

As with any shortcut, however, there are pitfalls.  There are three that I see with the Rule of 72:

  1. Taxes.   If you’re paying taxes on earnings, this needs to be considered in any calculation. So, if you’re earning 6%, but will pay some tax on that, your after tax rate may actually be somewhere in the neighborhood of 4% or so.  This needs to be factored in, or the Rule of 72 will give you erroneous results.
  2. Inflation.  Let’s say you’re earning 3% after taxes for example. If inflation is 3%, you’re not really getting ahead. The $1,000 you have invested will turn into $1030 a year later, but will still buy the same amount of goods as $1000 did the year before. So, inflation needs to be taken into account.
  3. Accuracy. This rule is meant to be a shortcut, so it’s not 100% accurate down to the decimal point. For example, if you wanted to see how long it would take to grow a $1000 investment into $2000, with a 3% rate of return, the Rule of 72 would tell you 24 years. If you calculate it manually, it actually comes out to almost 23 1/2 years. Close enough for an quick estimate, but important to note that it is in fact an estimate.

Personally, I find that many quick financial projections, particularly those that are intended to show the power of compounding over time, tend to ignore both taxes and inflation.  To the latter point, always keep in mind the time value of money.

In any event, as long as we’re aware of it’s limitations, the Rule of 72 can be a useful tool for quick projections of how long it will take us to double our money.

My Questions For You:

Have you ever used the Rule of 72?

Do you ever stop to question assumptions in such financial projections, such as I did with taxes and interest?

Comments

  1. Lizzy says

    Does the Rule of 72 work for debt too? Like if you have a credit card with a 11% intrest rate it would only take you 6 1/2 years to pay twice as much for something you bought.

    • Squirrelers says

      Lizzy – Good question, and yes – the rule of 72 could work for debt too. Let’s say you owe $1000 and are charged 18%. If you don’t make any payments, it will take you 4 years to double the debt to $2000 (72/18 = 4)

  2. Money Beagle says

    Yeah, I’ve used it just to ballpark rate of return. All of the factors you mentioned definitely have to be taken into play, at which point it probably makes sense to use an actual amortization tool, but for a look-see overview, the Rule of 72 works pretty well.

    • Squirrelers says

      Money Beagle – I agree, it’s good for a ballpark rate of return – at least for a high level overview.

  3. Little House says

    I’ve never heard the rule of 72, but it’s very interesting. I can see that it’s really just a method to calculate ROI on the fly and needs to be taken with a grain of salt, like you mention, taxes and inflation can dip into total value.

    • Squirrelers says

      Little House – the Rule of 72 is kind of a neat trick of math. The thing is, one must apply it in the right context. Like any other projection, taxes and inflation must be considered. However, for a high level ballpark estimate, it serves its purpose!

  4. cashflowmantra says

    I enjoy the rule of 72 and many other shortcuts in finance. I use them as a screening tool primarily. Of course the caveats of taxes and inflation should always be kept in mind, but for quick math without a calculator, you can’t beat these types of shortcuts.

    • Squirrelers says

      cashflowmantra – these shortcuts are nice to know, I agree. My inner math nerd comes out with such shortcuts:)

  5. First Gen American says

    You know, I don’t know what to use anymore. With the stock market all over the board, you can’t predict anything reliably anymore and frankly with current interest rates, calculating the rule of 72 on any safe investment is downright depressing.

    The only thing that’s a sure deal is continuing to save additional principle. I’ve kind of given up on the compounding interest idea myself. I know it’s not forever, but for right now, I don’t even want to do the math because it’s a downer.

    • Squirrelers says

      First Gen – Yeah, if you calculate it on a super safe investment, it puts in perspective. At 1%, it would take 72 years! :) Oh, and that’s before taxes and inflation….

  6. charles says

    oh cool, I never heard of it, but I like it. I just used an excel to see how accurate this rule was and it’s pretty close enough to use it as a rule of thumb. too bad the rates these days are pretty much close to zero.

    • Squirrelers says

      Charles – yes, the rates are beyond mediocre these days. It’s a neat trick, the Rule of 72…more fun to use when thinking about stock investments (even though those are more volatile) with higher returns over time.

  7. MoneyCone says

    I always use it for a quick mental calculation. It is easy to get bogged down with numbers, always good to know what a percentage implies.

    Neat tip Squirrelers!

    • Squirrelers says

      Money Cone – Yes, it’s good for just that. Glad you like the tip, of course it seems like you already use it:)

    • Squirrelers says

      Money Reasons – oh, so you’re like me, eh? I’m totally a spreadsheet kind of person too. These tricks like the Rule of 72 are just for when away from the laptop:)

  8. 101 Centavos says

    Agree, Squirrelers, it’s a good basic calculation that works well for fixed investments. For dividend-paying stocks, variables such as stock price and dividend increases (or decreases) will act in either direction.

  9. Gena Holden says

    It is easy to get bogged down with numbers, always good to know what a percentage implies. Of course the caveats of taxes and inflation should always be kept in mind, but for quick math without a calculator, you can’t beat these types of shortcuts.

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