Rule of 72

Have you heard of the rule of 72? In finance, Rule of 72 is a simplified method for estimating the doubling times for compounding interest. The rule of 72 can be applied in 2 ways.

72 / (Interest Rate) = No. of years for money to double

On the other hand, you can apply the rule of 72 this way

72/ (number of years to double) = Interest rate in percentage

In the article titled compound interest, I explained the difference between simple interest and compound interest. I’ve also shown how interest is compounded in long form calculation. The calculation below shows step by step how this is achieved. If you don’t have the time to calculate the individual steps or a financial calculator handy, you can use the rule of 72 for a close estimate.

Applying the rule of 72 to my previous example. In the previous example, assuming you invest 10,000, and the interest rate is 12% a year, the step by step calculation is as follows:

Year 1. 10,000 x 12% = $11,200
Year 2. 11,200 x 12% = $12,544
Year 3. 12,544 x 12% = $14,049
Year 4. 14,049 x 12% = $15,735
Year 5. 15,725 x 12% = $17,623
Year 6. 17, 623 x 12% = $19,738 or approximately 20,000

A far simpler and faster way is to use the rule of 72. Take the figure 72, divide it by the interest rate i.e 72/12 = 6 years. The figure you get is the number of years it takes your money to double, the same as the example above. In the formula, use the numeric for interest rate. Ignore the percentage. So if the interest rate is 10%, then it is 72 divide by 10, not 10%. You can try it for different interest rate and see that the results are fairly accurate.

The rule of 72 can also be used for estimating the time for halving your dollar value. If the inflation rate is 5%, then the number of years it takes for your money to be half its value is 72/5 approximately 14.2 years. So if you have $10,000 today, and you invest it an low interest rate vehicle, then, in slightly more than 14 years, your money will be worth only $5,000.

All the more reason to manage your money well.