Doubling Your Money with the Rule of 72
Did you ever wonder how financial professionals can so quickly mentally calculate how much money you’ll have in 30 years based on an investment return? Seems like magic, huh? Well, the magic can be easily attributed to the Rule of 72.
Although the Rule of 72 is a simple concept that many people already know about, it is nevertheless worth reviewing for those who don’t.
In order to utilize the Rule of 72, all you need to know is how to divide various numbers into 72. For example, 9 divides into 72 8 times. 10 divides into 72 7.2 times. Et cetera.
Once you have mastered the basic division tables for 72, you can start to apply this knowledge to calculations like investment returns. Divide the annual rate of return (expressed as a percentage) into 72, and the answer will be the number of years it will take for your money to double.
For example, if you assume your investment is earning 8%/year every year (and 8 divides into 72 9 times), then your money will double every 9 years. If you are earning 4%/year, your money will double every 18 years (72 divided by 4 equals 18). And so on.
This is an easy technique to quickly estimate what your net worth will be down the road given a certain rate of return. It may even help you decide what sort of investments to choose, based on their risk to reward ratios and historical performance rates.
If you have $10,000 invested at 3%/year for example, it will become $20,000 in 24 years (72 divided by 3 equals 24), and $40,000 in 48 years (24 times 2).
If instead you invest the same $10,000 at 6%, it will become $20,000 in 12 years, $40,000 in 24 years, and $80,000 in 48 years. (What a difference a rate of return can make, huh)?
The downfall of this easy calculation method of course, is that rarely do investments make “x”%/year, every year. You can achieve an average annual rate of return of “x”%, but in the end the total calculations won’t entirely reconcile with your Rule of 72 plan.
So all in all it’s a primitive method of planning your finances, but a useful tip for on-the-fly calculations, and maybe even a party trick or two.
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