The rule of 72 (Part 1)


If you’ve been reading about money for long, you may have heard of the rule of 72. If not, you should know that it’s a valuable tool in understanding the power of compound interest. This rule is that quirky little fact of compounding interest that allows us to predict how long it will take an amount to double. Let’s say that you have $100 in a savings account that earns 4% interest. (And wouldn’t that be nice, these days.) Now let’s say you want to know how long it’ll take, without additional deposits, to turn your $100 into $200. No complex math needed—just divide your interest rate (in this case, 4%) into 72. So, 72 divided by 4 equals 18. It will take 18 years for your $100 to double. Okay, so that’s a little depressing.

Why do we care about this anyway? Two main reasons. Here’s the good news: you can use the rule of 72 to help you decide where to invest (we’ll talk about the bad news tomorrow). Let’s take our same $100 and look what we can do with it at different interest rates. It’s important to remember that this rule applies to ANY dollar figure; it is the interest rate that’s important, not the amount.

Interest Rate Years to Double

4% 18

6% 12

8% 9

10% 7.2

12% 6

Kind of puts a new perspective on these dropping interest rates, huh?

The reverse calculation works as well, by the way. You can divide the number of years you want to invest by 72 to find the interest rate that will get you to your goal. So if you want to invest for 10 years and double your money, you need to find an interest rate of 7.2 percent or better.

The moral of the story: Use the rule of 72 to understand the value of compounding interest.

rule-of-72


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