How Does the Rule of 72 Work?

When I was in my 20s, I knew little about investing. Fortunately, I found a licensed financial coach who taught me the basics of investing and helped me create a customized plan to help reach my goals.

One concept my financial coach taught me was the Rule of 72. She said the Rule of 72 provided a general idea of how long it would take my money to double at a specific interest rate. She also let me know this Rule can work for or against me, depending on the situation.

How the Rule of 72 Works

To estimate how long it would take your money to double at a certain interest rate, divide 72 by the expected annual interest rate as a percentage. For instance, if an investment earns 8% annually, it would take approximately 9 years to double (72 / 8 = 9).

Similarly, you can apply the Rule of 72 to inflation by dividing 72 by the inflation rate as a percentage to estimate how many years it would take for your money’s purchasing power to be cut in half. For instance, if the inflation rate is 2%, your buying power would be reduced by half in 36 years (72 / 2 = 36).

Keep in mind that the Rule of 72 can work against you. For instance, if you carry a balance on a credit card charging 12% interest, you will owe double the amount in 6 years (72 / 12 = 6).

Accuracy of the Rule of 72

The Rule of 72 is more accurate in the range of 6-10% interest and is most accurate at an 8% interest rate.

• For increased accuracy in your estimates, consider using 69.3 rather than 72 in your calculations.

• To calculate an approximation based on a lower interest rate, such as 2%, use 71 rather than 72.

• To calculate an approximation based on a higher interest rate, add 1 to 72 for every 3 percentage-point increase. For instance, you would use 74 to calculate the doubling time for a 16% interest rate.

The Rule of 72 focuses on compound interest, where interest is earned on interest. For simple interest, where the interest is based on the principal amount, you would divide 1 by the interest rate expressed as a decimal. For instance, if you had $1,000 with a 10% simple interest rate, you would divide 1 by 0.1 for a doubling rate of 10 years.

How to Use the Rule of 72 for Investment Planning

Projecting how long it might take for an investment to reach a target amount at an average rate of return and a current balance creates an estimate of the monthly investment amount. For instance, if you are 22 years away from retirement and have $100,000 invested at 10%, your money should double approximately three times, to $200,000, $400,000, and $800,000. If the interest rate changes or you need more money because of inflation, you can use the results from the Rule of 72 to help determine how to continue investing over time.

You also can use the Rule of 72 to make decisions about risk versus reward. For instance, you might come across a low-risk investment yielding 2% interest and compare the doubling rate of 36 years with that of a high-risk investment yielding 10% that doubles in 7 years.

*This information is for educational purposes only.