Doubling your money may not be your primary goal when you make an investment, but it’s certainly a nice start. And knowing upfront about how long it will take to double your money is an easy way to gauge the value of an investment.
The rule of 72 is a quick calculation to determine the number of years it will take for an investment to double at a specific rate of return.
How do you calculate the rule of 72?
Calculating the rule of 72 is pretty simple. You just divide 72 by the annual rate of return. The quotient is a rough estimate of the number of years it will take for your initial investment to double.
The rule of 72 provides a rough estimate, but it’s not exact. For investments with lower rates of return, the estimate is closer to the actual result. For example, an investment with a 7 percent rate of return will double in 10.24 years, while the rule of 72 will estimate 10.3 years. An investment with a 50 percent rate of return will double in 1.71 years, but the rule of 72 will estimate 1.4 years.
Why do investors need to understand the rule of 72?
First of all, using this rule is a simple way to help you estimate how your money may grow over time. “This can help the investor to understand if they need to save more, and if so, how much more they need to save in order to reach their financial objectives,” says Chuck Mattiucci, AIF, senior vice president, Fort Pitt Capital Group in Pittsburgh.
Financial professionals will use the rule of 72 when they need to run a calculation “on the fly,” Mattiucci says. He says he often utilizes the rule to help a client to understand what rate of return they need to attain for their investment to double every 10 years. The quick calculation provides him with evidence to explain why he may recommend a certain allocation or investment model.
Mattiucci uses the 10-year time horizon because a rate of return of 7.2 percent is a ballpark requirement for the investment to double in 10 years. “Going back as far as 1957, the S&P 500 stocks have averaged an 8 percent annualized return,” he says. “So we feel that an investor with a fully diversified portfolio of stocks should reasonably expect to earn the 7.2 percent annually needed to see the investment double every 10 years.”
In addition to helping you set expectations for investment growth over time, the rule of 72 can also help you understand the need for stocks in a portfolio if you’re looking for growth. “If the investor is looking to double their money every 10 years, then they need a rate of return of 7.2 percent annually,” Mattiucci says. “Since stocks have returned a little better than 7.2 percent, they should make up most of the portfolio.”
The rule can also show you if your current portfolio isn’t set up to meet your needs. For instance, if you’re looking at a time horizon that is shorter than 10 years, you may “need to look for alternative investments that have a higher average rate of return,” Mattiucci says. “However, the investor should be aware that with a higher rate of return comes higher instances of volatility and risk.”
How should the rule of 72 affect my investment decisions?
You can use this simple rule to help you determine whether a specific investment is going to meet your goals, and adjust your portfolio accordingly.
For instance, say you want to amass $50,000 for your eight-year-old child’s college education. You have 10 years until the child turns 18 years old, and you have $25,000 to invest now. Based on the rule of 72, an investment with an average annual return of 7.2 percent should double in 10 years. So investing $25,000 in that investment should allow you to meet your goal within your timeline. Just be aware that 7.2 percent is an average and the market can go down some years.
The rule of 72 can be an easy rule of thumb to follow in selecting investments. “If investors know they have a long-time horizon, and they hope to have their money double every certain number of years, they can then determine what rate of return they need to achieve,” Mattiucci says. Once they know what rate of return they need, they can construct a portfolio that can help set them up to reach those goals.
Investing involves risk including loss of principal. This article contains the current opinions of the author, but not necessarily those of Acorns. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.