The Rule of 72, in simple form, divides 72 by the rate of return, and it will roughly show the number of years it will take for a portfolio to double in value. An example is an 8% return in a portfolio would double every 9 years (72 divided by 8 = 9), and a rate of 1% would take 72 years.
The Rule of 72 should be important to investors because it aims to illustrate the time value of money and the impact the rate of return has on future values. When evaluating an investment opportunity, the information provided by the Rule of 72 can be considered. For example, if investing in a long-term growth opportunity, you need to remember historical inflation rates and potential taxes to make an informed decision that aligns with your objectives.
The Rule of 72 does have limitations. One of those limitations is that it is less accurate with very high or very low interest rates. It works best regarding accuracy in a range between 6% and 10%. Another limitation is that it calculates annual compounding returns. The accuracy can be affected by market volatility or variable rates. Understanding the limitations, having the Rule of 72 as a starting point, and understanding how compounding works are essential.
The Rule of 72 is a quick and helpful tool, but it is not precise. One can use other formulas to calculate either lower or higher interest rates. You may need to use the Rule of 73 or 74 for higher interest rates or the Rule of 70 for lower rates. While not always precise, I reiterate that the Rule of 72 can provide an initial and general insight into the effect of the rate of return on doubling an investment.
There are more accurate tools, such as financial calculators, than the Rule of 72 formula. I recommend keeping the principles taught by the Rule when considering an investment. While not a precise tool, it does show the approximate long-term results of investing at particular interest rates. For example, an investment that is too conservative in the rate of return may be a “guaranteed” rate of return but may be a guaranteed failure if it does not meet the objective and need for the portfolio. If you have not already done so, I recommend starting with a general understanding and growing your knowledge. Your future self will likely thank you!
