The Rule of 72

Do you want to know how long it will take to double your money?  Most investors do.  Are you interested in the expediential growth of your money?  Have you ever tried to calculate the rule of 72?

When I first started to read personal finance and investing books, I learned about the math behind what makes investing work.  The big driver behind what causes your money to grow is compound interest. While I was studying, the one theory that I kept coming across was the rule of 72.

The rule of 72 is just a basic mathematical formula.  It is used as a tool to help investors determine when they should expect to double the money they currently have invested.  The rule of 72 allows an investor to know when they should expect to double their money based on a forecasted rate of return.

Start by taking the projected rate that you expect your investment to return every year.  Divide that interest rate by 72. That will give you the number of years that it will take for you to double your money.

Example:

72 / 6% expected rate of return = 12 years to double your principal

72 / 8% expected rate of return = 9 years to double your principal

72 / 10% expected rate of return = 7.2 years to double your principal

The rule of 72 is what makes stocks a more attractive option than bonds or other fixed-income investments.  For example, the Vanguard 500 (VFINX) has returned 10.97% per year between the years 1976 and 2016.  Currently, the average interest rate on an FDIC insured savings account is slightly higher than1.15%. What is the difference between these two investments based on the rule of 72:

Vanguard 500 – 72 / 10.97 = 6.56 years to double your principal

Saving account (national average) – 72 / 1.15 = 62 years to double your principal

Over the coming decade, stocks are not expected to return 10% per year.  Currently, stocks are expensive investments and there is not much value to be found.  Jack Bogle who founded Vanguard and the first S&P 500 index fund that was available to individual investors predicts a more modest return of 6 or 7 percent for the coming decade.  Based on that forecast and the rule of 72, how long would it take to double an investment of $3K in the Vanguard S&P 500 fund:

Vanguard 500 – 72 / 6.5% = 11 years to double your principal

Time is on Your Side

When I started investing, I received a brochure from the investment company that provided me with a few charts on compound interest.  The chart showed how the rule of 72 worked with different interest rates. The brochure explained the wealth-building power of stocks vs more conservative investments based on the difference in long-term performance.  It also showed how it benefited an investor who had a few decades to take advantage of this powerful wealth building formula.

For example, a one-time investment of $10K to grow in value to $40K based on different interest rates:

  • If an investor received a return of 3%, it would take 48 years for that $10K to grow to $40K
  • If an investor received a return of 6%, the time would be reduced to 24 years to grow to $40K
  • If an investor received 12%, however, it would only take 12 years to grow $10K to $40K

What to do Now

What can investors do now to follow the rule of 72?  What are some alternatives since the S&P 500 is projected to underperform its historical average?  Is it possible to try to reduce the time it takes to double your money without taking on too much risk?  Here are some options that might help in doubling your money quicker:

Save more money.  By increasing your savings, you will double your money at a faster pace.  Try to increase your savings by 2-3% per year.

Go beyond the S&P 500.  Add a small-cap blend or extended market index fund that includes mid-cap stocks to your asset allocation.  Small-cap stocks have historically outperformed large-cap stocks. If you go with a 4:1 Ratio, you will emulate the total stock market.

Go beyond the United States for investing opportunities.  Add some international stocks to your portfolio. Add both developed nations and emerging markets for their growth potential.

Remember to keep some bonds in your portfolio.  Many experts are telling investors to stay away from bonds because of their current low yield and the raising interest rates.  Bonds have an opposite correlation than stocks. When stocks go down in value, bonds go up. By owning some bonds, you can buy stocks at a lower price when there is a stock market correction.

Conclusion  

As an investor, you should keep the rule of 72 in the front of your mind.  You do not need to know the exact date as to when you will double your money.  From time-to-time, look at how your portfolio performed over the past 5 or 10 years to identify what your average rate of return is.  Apply the rule of 72 to know where you stand. If you are not satisfied with how long it is taking, look for ways to increase your returns that are within your risk tolerance.   

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One thought on “The Rule of 72

  1. Cooper The Millennial

    Thanks for the article FJM. This succinctly explains the rule of 72 which can be confusing to some.

    I certainly hope that our equities continue to rise, but at some point the party does have to end before the next one can start.

    Reply

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