There are many different formulas investors can use to determine how their money will grow over time.
Growth rate in personal finance is represented as a percentage change of a specific amount of money over a given time frame. In other words, how much will $1 million grow over 20 years at an 8 percent annualized growth rate? Furthermore, the rule of 72 is a calculation that provides an estimated amount of time to double your money at a specific rate of return.
In this article we’ll take a look at the rule of 72 and give a few examples of how it works.
How Does the Rule of 72 Work?
The rule of 72 is a calculation that investors can use to determine how long it will take to double their money at a fixed rate of return. Here are a few examples of how it works:
- If you have a brokerage account with $500,000 at a 6 percent rate of return, divide 72 by 6 to find out how long it will take to grow that account to $1 million – 12 years.
- If you have a $2 million investment that’s returning 4 percent, it would take 18 years to grow that account to $4 million.
- Your investment account holds $250,000 and earns 8 percent. It would take nine years to grow that account to $500,000 provided you have consistent returns.
It’s important to note that the rule of 72 isn’t 100-percent accurate. Eight percent is the standardized rate of return for the most accurate estimates provided under the rule of 72, and the further you move up or down from that growth rate the results get less reliable.
Why Is the Rule of 72 Important?
The rule of 72 is important because it demonstrates the importance of saving and growing capital. It can be extremely useful as a retirement planning tool to help you determine how much you need to save for a comfortable retirement, and how long you’ll need to leave investment capital alone in order to meet your fiscal retirement goals.
For example, if you expect to need $1 million to retire comfortably, but you only have $400,000 saved, you’ll need to have that money double 1.5 times at an 8 percent annual interest rate – that’s 13.5 years.
The rule of 72 also can be helpful in making investment decisions. Should you tie up $100,000 at 2 percent interest, which would take 36 years to double, or should you invest at a 6 percent expected rate of return, which would take 12 years to double?
The Bottom Line
The rule of 72 is a mathematical concept investors can use as a gauge for how quickly their money will grow at a steady rate of return. The formula uses a fixed rate of return, which is not indicative of real investments that commonly have fluctuating return rates. It also doesn’t take into account taxation, fees, or other costs that could impact your investment’s performance. With that in mind, use the rule of 72 only as a back-of-napkin calculation rather than a concrete formula to determine how your investment capital might grow over time.