Compounding returns are critical to building wealth. For example, if you invested $250 a month in a mutual fund earning the average historical stock market return (around 10.5%), you’d be a millionaire in under 36 years.
But not all of us sit around all day playing with compound interest calculators. It helps to have a shorthand rule of thumb sometimes.
Enter: the Rule of 72.
What’s the Rule of 72 in Finance?
To calculate how long it will take an investment to double, you can just divide 72 by the return you expect to earn.
For instance, if you expect a 10% return, you can expect your money to double within 7.2 years or so: 72 / 10 = 7.2.
Not exactly advanced calculus, is it?
The Rule of 72 isn’t precisely accurate. But for back-of-the-napkin calculations, it’s very close — at least for common returns ranging from 6-10%. More on variations of the Rule of 72 in investing later.
Formula for the Rule of 72
The formula for the Rule of 72 is pretty simple:
Years to double = 72 / rate of return on investment (ROI)
As another example, if you expect to earn 8% on an investment each year, then it would take 9 years for your initial investment to double: 9 = 72 / 8.
Note that you enter the ROI as a number, not a decimal of 1. So, instead of using 0.08 to express 8%, you just use 8.
You don’t have to use whole numbers, either. If you invest in real estate crowdfunding platform Streitwise, which pays an 8.4% annual dividend yield, you could expect to double your money in 8.6 years (8.6 = 72 / 8.4).
Also bear in mind that the Rule of 72 in finance doesn’t take additional contributions into account. It only calculates the time period for a one-time initial investment to double if the returns are reinvested.
Finally, the Rule of 72 assumes that the return compounds annually. For investments that compound monthly,quarterly, or semiannually, it’s less accurate.
Uses of the Rule of 72 in Investing
As noted above, you can use the Rule of 72 to figure out how long it will take an investment to double.
That’s especially useful if you’re thinking about CoastFI. For non-FIRE nerds (FIRE: financial independence, retire early), CoastFI refers to building up a nest egg quickly, then not investing another cent until you’re ready to retire. (Read more about the steps to financial freedom here.)
So for example, you might save up $500,000 in a sprint, then stop saving, secure in the knowledge that your investments will compound over time and deliver a juicy enough nest egg by the time you want to retire. The Rule of 72 suggests that your $500,000 will double to $1 million in 7.2 years if you’re earning a 10% return. You could retire then if you’re happy with that nest egg, or leave it for another 7.2 years to double again to $2 million. Leave it for another 7.2 years, and you’d have $4 million.
That exponential growth shows the power of compound interest.
You can also use the Rule of 72 in investing to determine the annual rate of return you’d need for your investment to double within your target time frame. So, you tweak the formula to divide 72 by the number of years you want your money to double in.
Say you want your investment to double in just five years — by the Rule of 72, you’d need to earn a 14.4% return on your investment (72 / 5 = 14.4%). You now have a target return in mind, which will help you decide where to park your money.
