The Rule of 72 is a simple way to find out.
The Rule of 72 calculates the number of years it takes an investment to approximately double in value. You simply divide 72 by any average annual growth rate and you’ll have the number of years it would take to approximately double in value. The Rule of 72 can show you how just a small difference in your rate of return can have an impact on how much money you could ultimately have. It can also be useful when calculating how long it might take for creditors to double the amount of interest you are paying them.
The Rule of 72 can be useful for:
Your investments
To show you how the Rule of 72 works, let’s take a look at how long a hypothetical investment would take to approximately double in value at different average annual returns. With an annual 4% return, it would take 18 years (72/4) to approximately double. With a 6% return, it would take 12 years (72/6), while with an 8% return it would take 9 years (72/8). So as you can see, even a small increase in average annual return may reduce the number of years it would take for an investment to double. Of course, making ongoing contributions to your retirement plan can greatly increase your savings beyond the rule of 72.
Interest on debt
You can also use the Rule of 72 to plug in interest rates from credit card debt, a car loan, home mortgage, or student loan to figure out how many years it’ll take your money to approximately double for a lender. For example, let’s say the effective interest rate for your credit card(s) is 18% after making the minimum payment. If you divide 72 by that rate, you get 4 years. That’s how long it would take for a credit card company to earn double your money. If you have debt, look into the possibility of refinancing your car loan or mortgage to get a lower interest rate. You can also contact your credit card providers and ask if you can get any reduction in the interest rates applied to your card balances.
Historic investment performance
When determining the return divisor of the Rule of 72, it’s important to understand how the financial markets have historically performed. Over the last fifty years, stock investments have dramatically outperformed bonds and fixed-rate investments. At the same time, stocks have been subject to periods of temporary and occasionally sharp declines. By knowing the historic long-term performance of the investment components of your portfolio, you can estimate the return divisor of the Rule of 72 and the amount of time it might take for your investment portfolio to approximately double in value.
The power of time
Hand-in-hand with the Rule of 72 is the power of long-term compound growth. The underlying principle of compound growth is that investments may earn interest and/or investment returns, and, over time, those returns may also earn their own interest and/or investment returns on top of the original investment. The power of time accelerates over time as an investment potentially grows in value. Each year an investment may grow in value, so does the amount of interest earned. For example, a hypothetical $10,000 investment earning a fixed 6% growth per year would grow to 10,600 after one year ($600 in interest). In year 10, a $16,895 balance would grow to $17,908 ($1,014 in interest), and in year 20, a $22,609 balance would grow to $23,966 ($1,357 in interest).
We are here to help. Contact us today. We can also discuss some creative ways to save so you can take more advantage of the power of time.
