#Household math, #Investing - The Rule of 72

Question

I've heard of something called the Rule of 72 but I have no idea what it is.

Answer

It's a quick calculation used to figure out how what factors are needed (in terms of time and average return) needed to double your money.

Analysis

There are two basic factors that play into how an investment (or group of investments, such as a mutual fund portfolio) will do over a substantial number of years:

• the average rate of return, and 
• the number of years the investment is held.

So let's say for a minute that I have an investment and I anticipate making 6% per year on it and I plan on holding it for 12 years. Well... so what - is there some way to get an easy to understand number from these two details?

This is where the Rule of 72 comes in. It gives a quick answer to the question of "How long will it take to double my money". We take the average rate of return without the percentage mark (so in this case 6) and multiply it by the number of years to be held (in this case 12) and then multiply them together:

6 X 12 = 72

And so at the end of 12 years we can anticipate that our money would have roughly doubled.

We can work this another way - if we wanted to know the number of years we had to hold an investment for it to double at a 6% average return, we can divide 72 by 6 to get 12 - which is to say that every 12 years we can anticipate our investment doubling.

This becomes a very powerful tool when young people are first looking at putting some money away for retirement. For instance, if at age 25 someone puts $10,000 into a retirement account and anticipates 6% return per year, we know that every 12 years the money will double. If the person wants to access that money at age 60, it'll double 60 / 12 = 5 times. And so the value of that 10,000 will have become $320,000.

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Questions and comments always welcome!