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Investing 101

Rule of 72 and the Power of Compounding Interest

Rule of 72

Have you ever wondered how long it would take to double your money? The timeframe could be anywhere from a few years to most of your lifetime, depending on the rate of return you’re earning. That brings us to the “Rule of 72.”

What is the Rule of 72?

The rule of 72 is a quick and easy way to estimate how long it will take to double your money at a given compound annual interest rate. Compound interest means that the interest you earn each period (month, quarter, etc.) is added to your principal and in turn, earns interest in future periods. This interest on interest allows your total balance to grow at an increasing rate as the amount of interest earned increases each period, even if you add nothing else to the account.

For example, assume you deposit $5,000 in an account that earns 2%, compounded annually. In the first year you would earn $100 interest ($5,000 * 2%), in the second year you would earn $102 interest ($5,100 * 2%) and by the third year, you would earn $104 ($5,202 * 2%). Over time, compounding will allow your account to grow faster and faster, eventually doubling your money. The rule of 72 is used to estimate just how long this will take.

How do you use the Rule of 72?

To use the rule of 72, divide 72 by the annual rate of return you expect to earn on your investment. For example, if you put your money into an account earning 2% compounded annually, it would take 36 years to double (72/2). If your money earned 6%, it would double in just 12 years (72/6). Knowing this can help you make a plan to reach your goals. You’ll be able to estimate how much you need to save and what return that money will need to earn. You’ll find tips like this and other free planning tools on the US Securities and Exchange Commission information site: https://www.investor.gov/

How to make the Rule of 72 double your money faster

Rule of 72

One way to double your money faster is to put a portion of your portfolio into investments expected to earn a higher return. For example, the DiversyFund Income Fund pays quarterly distributions and has returned 11.5% annualized in its 5-year history. It targets annualized returns of 9-11%. Assuming it earns just the minimum target of 9%, using the rule of 72, you could expect to double your money in 8 years (assuming reinvestment of distributions).
It’s important to remember that investment returns vary from year to year, but when planning for a long-term goal, the rule of 72 is a convenient way to estimate where you could be a few years down the road.

Who discovered the Rule of 72?

This rule of thumb may be brilliant, but contrary to popular belief, it was not Albert Einstein who came up with it. The calculation has been around for hundreds of years and was first published in the late 1400s by Luca Pacioli, an Italian friar, and mathematician who helped develop modern accounting.

(Source: Wall Street Journal, Saturday-Sunday June 17-18, 2017)

 

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