Rule of 72: What It Is and How It Works
The Rule of 72 is a simple method used to estimate approximately how long it may take for an amount of money to double at a constant annual rate of growth.
What Is the Rule of 72?
The Rule of 72 provides a quick approximation of the number of years required for an investment or amount of money to double when it grows at a relatively constant annual percentage rate.
Estimated Years to Double = 72 ÷ Annual Rate of Return
The annual rate is expressed as a percentage. For example, a rate of 8% would be entered as 8 rather than 0.08 when using this simplified formula.
How Does the Rule of 72 Work?
The calculation divides 72 by the assumed annual rate of growth. The result provides an approximate number of years required for the original amount to double under the assumptions used.
If an amount grows at a constant annual rate of 8%, the estimate would be:
72 ÷ 8 = 9 years
This means the Rule of 72 estimates that the amount could approximately double in around nine years, assuming a constant 8% annual compounded growth rate and no withdrawals, additional contributions, taxes or fees.
Another Example
72 ÷ 6 = 12 years
Under this simplified assumption, the amount could approximately double in around twelve years.
Why Is It Called the Rule of 72?
The number 72 is convenient because it has many divisors and can provide a relatively useful approximation across a range of moderate growth rates. It is a shortcut rather than an exact financial calculation.
Rule of 72 and Compound Growth
The Rule of 72 is commonly associated with compound growth. When positive returns remain invested, future growth may occur on both the original amount and previous growth.
Actual investment returns are not constant, however. Market values can rise and fall, and actual results may differ significantly from an estimate based on a fixed annual rate.
Using the Rule of 72 for Inflation
The Rule of 72 can also be used as a rough way to think about how quickly purchasing power may decline when prices rise at a constant rate.
At an assumed inflation rate of 6%, dividing 72 by 6 gives approximately 12 years. This can be interpreted as a rough estimate of how long it might take for the general price level to double under a constant 6% inflation assumption.
Limitations of the Rule of 72
The Rule of 72 is only an approximation. Real-world investments and financial products can produce different results because returns may fluctuate and many other factors can affect outcomes.
- Investment returns may not remain constant.
- Market investments can experience gains and losses.
- Fees and expenses can reduce returns.
- Taxes may affect net growth.
- Additional contributions or withdrawals can change results.
- The formula becomes less precise at some very high or very low rates.
When Can It Be Useful?
The Rule of 72 can be useful as a quick educational estimate when comparing the potential effect of different assumed growth rates or inflation rates.
It should not be treated as a guarantee or a substitute for a detailed financial calculation.
Key Takeaways
- The Rule of 72 estimates approximately how long it may take for an amount to double.
- The basic calculation is 72 divided by the annual percentage growth rate.
- It is generally used as a shortcut for understanding compound growth.
- It can also be used to think about the potential effect of inflation over time.
- It is an approximation, not an exact prediction.
- Actual investment returns can fluctuate and are not guaranteed.