When you are planning your finances, it can be helpful to know a quick way to estimate the future value of an investment. The Rule of 72 is a simple formula that allows anyone to calculate the length of time it will take for an investment to double in value. With this estimate, investors can plan for the future knowing roughly how much they will yield from an investment at certain increments of time. It is also useful for making any kind of investment decision because it focuses only on growth rate. This blog is a part of a series written by our summer intern, Makenna. This series is based off excerpts from the well-known book, A Random Walk Down Wall Street.
All you need in order to use this formula is the rate at which you expect your money to grow. After you calculate the doubling time, you can compare it to your initial investment to see how much your money will grow over time. The Rule of 72 states that by dividing 72 by your percentage of growth, you can calculate the number of years it takes for your investment to double in value. For this example, I will use a 10% growth rate and an initial investment of $5,000. Using the Rule of 72, I can calculate (72/10)= 7.2. This means that it will take 7.2 years for my investment to double. In addition, if the growth rate stays the same, I can expect the same doubling time in the future. $5,000 becomes $10,000 in 7.2 years, and then it becomes $20,000 after another 7.2 years. This Rule of 72 is helpful because it does not depend on the amount of money you invest. It simply explains how much time it will take for an investment to double. Using a 10% growth rate, we know that $5,000 will become $10,000 in 7.2 years but also that $250,000 will become $500,000 in 7.2 years.
This information is applicable to any kind of investment including stocks, retirement accounts, bonds, savings accounts, etc. If it has a growth rate, you can use the Rule of 72. However, it is important to note a few precautions before relying on this method to predict future performance. First, companies do not last forever. When you invest, you always take on the risk that a company could dissolve. Of course, some investments are backed by insurance, but for the most part, risk can affect the value of your investment. Therefore, the Rule of 72 is not a perfect formula because it ignores the lifetime of a company. Also, the Rule of 72 is just an estimate. It is a good estimate considering how easy it is to calculate, but it is usually not accurate when compared to the longer financial forecasting calculations. Growth rates often change over time which further proves the instability of this formula. The purpose of the Rule of 72 is to give you a quick estimate of doubling time and nothing more.
Whether you are forecasting for your retirement or simply wondering what your investment will yield in a few years, the Rule of 72 is a helpful tool for visualizing future returns. This formula is used by new and experienced investors for a quick glance at potential growth over time. As long as you consider the faults of this formula in your calculations, the Rule of 72 is a great way to help you make wise investment decisions.
Summer Intern / Berry College Student