What is the Rule of 72, and why does it matter?

Daftar Isi

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This straightforward formula can give you a rough idea of how long it'll take for an investment to double in value, giving you a quick snapshot of the potential effect of your financial choices.

What's the lowdown on the Rule of 72, anyway, and why's it a big deal?

What's the Rule of 72?

The Rule of 72 is a quick mental math formula which works out how many years it'll take for an investment to double at a fixed yearly interest rate. The formula is:

Number of Years to Double = 72 / Annual Rate of Return

Have you got an investment expected to grow at an annual rate of 6%? The Rule of 72 can tell you that your money will take roughly 12 years (72 ÷ 6 = 12) to double.

The simple beauty of the Rule of 72 is that it allows you to easily work out how much of an impact different rates of return can have on your investments, all without needing to use a calculator.

of approximately 7%.

What's the relevance to making smart investment choices?

This is helpful when assessing various investment options.

Let's explore this concept in more detail by talking about how, over the long term, share prices normally match up with a company's underlying earnings growth rate.

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Increased from 1.5 cents in FY14 to 79.1 cents in FY24, meaning a 49% compound annual growth rate. Its share price grew by 13,170%, or approximately 65% per year, during this time.

Recently, the company's earnings per share have increased by about 30% annually over the last three years.

Shares that have grown by 1930% over the past 10 years, which works out to a compound annual growth rate of about 34%.

Over this time frame, its EPS moved from 3.4 cents in FY14 to 45.5 cents in FY24, with a compound annual growth rate of 30%.

They may think from these two examples that

• If the company can keep its annual profit growth at 30%, the investment in these shares could double in just 2.4 years.
• If earnings growth drops to 20% per year, invested funds would double in three and a half years.

This is a handy way to get a rough and ready estimate.

Other implications

Investors often have sky-high expectations about how quickly their cash can grow. By using the Rule of 72, you can set more achievable goals and get a better understanding of the time frame it'll take to reach them.

For example, if you're expecting your money to double in five years, you'd need an annual return of about 14.4% (72 ÷ 5 = 14.4%), which is a pretty high rate and not usually achievable in most regular investments.

Investing or going for a more cautious approach, the Rule of 72 can give you a fair outlook on your choices.

If you're thinking of buying a stock with a 9% return as opposed to a bond with a 4% return, the Rule of 72 says the stock could double your investment in eight years, whereas the bond would take 18 years.

Foolish takeaways

G'day, mate! The Rule of 72 is a ripper tool for anyone lookin' to get a handle on how compound interest affects their investments.

This straightforward formula can help you make smart financial decisions and give you a clear idea of when your money will be doubled by telling you how long it will take.

Whether you're saving for retirement, planning a big buy or just interested in how your money can grow, the Rule of 72 is a vital concept to have in your financial toolkit.

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This article contains general investment advice only (under AFSL 400691). It has been authorised by Scott Phillips.