The Rule of 72

Recently I wrote about the Rule of 72 and pointed out that it was wonderfully simple tool which can be used in many circumstances.

Just to refresh your memory it is an easy way to do compound interest calculations in your head. The best part is that you don’t have to be a mathematician to use the Rule of 72? It’s simple, but once you understand how to use it, you’ll wonder how you got by without it.

It works like this – divide the number 72 by the expected rate of return – the answer is the number of years it will take for a given sum to double at the expected compound rate of return. Alternatively, divide 72 by the time frame in years and this will give you the forecast percentage return.

Suppose your home is worth $400 000 today and you predict it will increase by 7% per annum. Divide 72/7% and the answer is close to 10. If your prediction is correct, your house will be worth around $800 000 in 10 years, and $1.6 million in 20 years.

Understanding the Rule of 72 also emphasises the power of time. Suppose you and your friend were both left $100,000 at age 25. Your friend was extremely cautious and earned 4% a year on the inheritance, you were smarter and managed to earn 8% a year. This means your friend’s money is doubling every 18 years, and your money is doubling every nine years. After 18 years their money is worth $200,000, and yours is worth $400,000 because you have had two doubles and they have had just one. In a further 18 years their money would have grown to $400,000 – yours would have grown to is $1.6 million. That’s the power of compounding.