Today’s post is brought to you by the number 72! No really, it is. Because 72 is an awesomely useful number in the world of personal finance. It can be used to figure out when (approximately) your investment in something will double.
It’s super easy. Let’s say you’ve got your money in a stock that grows by 6% each year, on average. Without buying any more of that stock, when will your money double through compounding alone?
Just divide magic number 72 by the interest rate (6%), and BOOM, you’ve got your answer! 72/6 = 12. In 12 years, your investment will double. So if you own $1000 worth of that stock right now, and it grows at 6% per year, it will be worth $2000 in about 12 years.
Of course, the “Rule of 72,” as this is called, doesn’t always work perfectly. You can really start to see it fall apart as you try to use higher interest rates. For example, 100% interest should double every year, but using the rule of 72, you’d get about 9 months. Hmm, that’s not right! But for most realistic percentages, it works out pretty well. (Because you’re not really going to find an investment that returns 100% per year, year after year, anyway. Sorry!)
The Rule of 72 can also be used to do a back-of-napkin calculation regarding inflation. As long as you can remember the Rule of 72, and the fact that inflation averages about 3.5% per year in America, you can figure out when the price of something is likely to double. 72/3.5 = ~20, so in 20 years you’ll be paying twice as much for a gallon of milk!
Play with it, have some fun! And remember, your money will double every x years, not just once. So going back to that $1000 at 6% example, not only will it be $2000 in 12 years, but it will be $4000 12 years after that, and $8000 12 years after that…
The Rule of 72 doesn’t allow for an easy calculation of it, but now imagine how your money would grow if you were investing $1000 each year, instead of just once. Ooo… I just got goosebumps!
I love the rule of 72. As a dividend investor I can use it – if I know that a company has consistently raised its dividend by 8% for the past few years, and I make the assumption that it will continue to do so (a big assumption mind you), then I can calculate that that my dividend income will double in 9 years. Amazing.
However, as I mentioned, this assumes a constant growth rate over that period of time.
I’d never heard of the rule of 72 before but from what you say it makes perfect sense – i’ve been investing in shares for a while now but never looked at payback in these terms.
A great formula for investors. Looks like the interest rates won’t be climbing back up for quite a while now though, so there won’t have to be too much adjusting on the rule. With the economy continuing to fall, even though more slowly, it seems the rule of 72 is probably less consistent then during boom times.
69 is a bit closer to the mathematical answer; the “rule of 72” is used because 6*12 and 4*18 go into 72 exactly.
I have a 72 story for you.
I was in grad school, and the Prof made a remark about selling Manhattan in 1626 for $24. He asked what it should be worth today at an expected market rate of 6% total return.
I looked up and said $24 billion. (Note, this was in 1986, very conveniently). He asked where my ‘work’ was, and I showed him my hands. Of course over that number of doublings the errors added up to my being 28% off, the answer being closer to $30.9B. Less than 5 years off on 360, still not bad.
BTW, jump to 8% and the answer (on my fingers) is $24 trillion, with actual number $25.9 T.
Fun stuff.
I love the rule of 72; it’s such a handy little shorthand. I actually had a situation where I was asked about the time it would take to double your income, and the rule of 72 let me do the calculation in my head. Go, rule of 72!
They say that you can also apply the rule of 72 shortcut to many different things. Just like savings account growth, the effects of inflation, and the growth of a debt from the interest charged.
I don’t understand why I’ve never come across this rule before, that is awesome. I’ve just used it on some investments I made recently and it’s pretty accurate, what a brilliant post.