All about the Rule of 72 in Investing!

Setting goals when it comes to managing your money helps add a touch of discipline to the whole process because you also start thinking about the best possible ways to achieve that goal. Most investors are likely to have a target in terms of the returns they expect from their investments but are still determining the time within which those return expectations will be met. Or, they have an investment horizon in mind but are still determining investment avenues that will give the desired returns. But what if there’s a simple calculation that can help you get started? Let’s say you want to double your money but decide to keep the investment horizon more open. Naturally, you would like to know how long your investments will take to double. Is there a way of finding that out? Yes, there is using a calculation called the Rule of 72. This article will explain how it works and whether it can be relevant when considering various investment options, including investments in mutual funds.

What is the Rule of 72?

The Rule of 72 is a formula that can help you understand the time it will take to double your investment at a particular annual interest rate. This calculation will work if the interest is fixed and not fluctuating. It also tends to be effective with investments that use compound interest rather than simple interest.

While this is a convenient rule to determine the time likely taken to double your money quickly, what you get is an estimate rather than a precise result. Therefore, it helps to remember that this formula can give decent results under certain circumstances and not always. For instance, this formula is likely to work best when the annual interest rate is between 4% and 15%. Beyond these boundaries, the result could turn out to be unreliable.

However, despite its flaws, the formula also has its fair share of advantages – it is simple to use, does not involve complicated mathematics, and can help investors adjust their investment portfolios accordingly.

Moreover, the Rule of 72 can also be applied to anything that grows at a compounded rate, such as gross domestic product (GDP) or population.

As an investor, you need to set your investment goals based on your risk appetite. If your risk appetite is lower, you might prefer debt over equity. Suppose you have long-term goals such as your children’s education or retirement. In that case, you might prefer equity and equity mutual funds, which despite the higher risk, are likely to deliver better returns over the long term. In either scenario, you can use the Rule of 72 calculation to help you understand the time taken for your investments to grow or even to decide which investments might best suit your needs.

Rule of 72 Formula

The Rule of 72 formula can be expressed in two different ways:

Option 1: Determining the doubling period

Number of years to double investment = 72/annual rate of interest (or return)

Option 2: Determining the required rate of return

The annual rate of interest (or return) = 72/Years to Double

Ideally, the annual interest rate must be compound interest instead of simple interest.

Rule of 72 Example

Here’s an example to help you understand the Rule of 72.

Let’s say you invest in an asset class that is likely to offer 8% annualised returns; then, by applying the formula, it will take 9 years to double your investment (72/8 = 9).

Or, using the reverse formula, if you want your money to double in 6 years, you will likely have to invest in assets that can generate annual returns of 12% and more (72/6 = 12).

As mentioned earlier, the Rule of 72 formula can also be used for broader macroeconomic indicators. Let’s say the annual GDP of a country is growing at 7%; then it will take around 11 years for the economic growth to double (72/7 = 10.3).

How to Double Your Money with Rule of 72?

As mentioned earlier, you can reverse the Rule of 72. For instance, if your goal is to double your money and you are also certain of your investment horizon, then the rate of return will be the output. In such a scenario, you can plan or research the investment avenues that can help double your money within your specified time horizon.

Let’s say you have a five-year investment horizon within which you wish to double your investments. Thus, applying the formula, you get annualised returns of 14.4% (72/5 = 14.4). This means you need to invest in those asset classes that can offer annualised returns of around 14.4% or more. If you factor in inflation, then the expected returns must be higher.

If you are a very long-term investor and wish to double your money in ten years, then it makes sense to look at asset classes that offer annualised returns of 7.2% and more (72/10 = 7.2). For instance, a combination of debt mutual funds and some traditional financial instruments can help you reach that goal.

To conclude

It is not necessary that you must always look to double your investments. If that happens, it’s, of course, excellent. But depending upon market conditions and other circumstances, those return expectations may or may not be met in that stipulated time. Also, different asset classes behave differently, and doubling your money is never a guarantee. But even if doubling your investments is not your goal, there’s no harm in arriving at a ballpark figure of the time taken to achieve this as a reference point. And in this regard, the Rule of 72 calculation is as good a reference point as any.