How to Use Rule of 72
What are your goals? Do you want to buy a home? Do you want to provide a college education for your child? Do you want to retire? Goals are personal to you, but what is important is that you have a clear vision of how money works through the magic of compounding interest. The “Rule of 72” should be used in your financial goal setting. “Rule of 72” is a simplified way to calculate how long an investment takes to double, given a fixed annual rate of interest. For example, let’s say you have an investment that pays 2% a year. With Rule of 72, you would divide 72 by 2 and you would know that it would take 36 years to double your money. If you wanted to double your money in 8 years, you would take 72 and divide it by 8. The result would show that you would have to earn 9% a year for 8 years for you to double your money. These numbers are multiples of 72.
Let’s take a look at the following chart for a 30 year old investor who makes a one-time investment of $10,000.00.
| Age | 2% | Age | 9% |
|---|---|---|---|
| 30 | 10,000 | 30 | 10,000 |
| 66 | 20,000 | 38 | 20,000 |
| 46 | $40,000 | ||
| 54 | $80,000 | ||
| 62 | $160,000 | ||
| 66 | $222,000 |
If she invests $10,000 and earns 2% a year, it would take 36 years to double to $20,000 with compounding of interest, assuming the investor reinvests the income each year.
If she invests $10,000 and earns 9% a year, in that same 36 years it would turn into $222,000 with reinvestment of dividends and capital gains. Her $10,000 investment would double in only 8 years.
Rule of 72 demonstrates how time and the rate of return can have an impact on your investment dollar. Even a few percentage points can make a difference of thousands of dollars over time because of the magic of compounding interest. Does earning 3% more make a difference over time? Let’s take a look at a one-time investment of $1000.00.
| 1% | 3% | 6% | 9% | 12% | 15% | |
|---|---|---|---|---|---|---|
| 10 Years | 1,104 | 1,343 | 1,790 | 2,367 | 3,105 | 4,045 |
| 20 Years | 1,220 | 1,806 | 3,207 | 5,604 | 9,646 | 16,366 |
| 30 Years | 1,347 | 2,427 | 5,743 | 13,267 | 29,959 | 66,211 |
As you can see, over a 30 year period, the magic of compounding interest can bring you closer to your goals. Understanding how money works is necessary in putting your financial goal plan into action.