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The Rule of 72 is a powerful formula that can truly change your life regarding your finances and investing. This simple mathematical concept reveals the extraordinary impact that compound interest can have on growing your money over time. By dividing 72 by your expected annual rate of return, you can estimate how many years it will take for your investment to double.
Understanding and applying the Rule of 72 clarifies personal finance and wealth-building principles. It emphasizes why starting to invest early, being consistent, earning higher returns on your assets, and letting compounding work its magic over decades is critical. Even if growth seems painfully slow initially, this formula shows why persistence and lifelong investing pay off exponentially in the long run.
In this article, we’ll explore the Rule of 72 in depth. You’ll learn the math behind why it works and see practical examples of how different rates of return and time horizons impact your investment doubling rate. We’ll also discuss key lessons and takeaways from this powerful concept that can change your money mindset and set you toward financial freedom.
What is the Rule of 72 concept?
The Rule of 72 is a simple way to estimate how long it will take for an investment to double in value when it is earning compound interest.
Here is a detailed explanation:
The Rule of 72 states that you can divide the interest rate of an investment by 72 to determine approximately how many years it will take for that investment to double. For example, if you have an investment earning 6% interest per year, you divide six by 72, which equals 0.0833. This means your investment would take about 8.33 years (rounded up to 9 years) to double at that interest rate.
The math behind why this approximation works is based on the principle of compound interest. Compound interest is when you earn interest not only on your original principal but also on the interest that the principal makes over time. This causes your investment to grow at an exponential rate. Your money starts making you money as it grows.
The Rule of 72 works because, mathematically, dividing 72 by the interest rate (72/r) gives you the approximate number of periods (usually years) needed for the investment to double. This is because of how compounding works – after enough periods, the accumulated interest will eventually reach 100% of the original principal.
So, in summary:
- Divide the interest rate by 72 to get the approximate number of years to double
- The formula works due to compound interest causing exponential growth
- It allows quick mental math to estimate investment doubling time based on returns
The Rule of 72 helps get a rough estimate, but keep in mind it loses accuracy for higher interest rates or more frequent compounding periods. Overall, it provides a handy shortcut to understand compound interest and capital gains effects on capital growth.
Rule of 72 examples:
| Interest Rate | 72 divided by the Interest Rate | Years to Double |
|---|---|---|
| 1% | 72 / 1 = 72 | 72 years |
| 2% | 72 / 2 = 36 | 36 years |
| 3% | 72 / 3 = 24 | 24 years |
| 4% | 72 / 4 = 18 | 18 years |
| 5% | 72 / 5 = 14.4 | 14 years |
| 6% | 72 / 6 = 12 | 12 years |
| 7% | 72 / 7 = 10.29 | 10 years |
| 8% | 72 / 8 = 9 | 9 years |
| 9% | 72 / 9 = 8 | 8 years |
| 10% | 72 / 10 = 7.2 | 7 years |
| 11% | 72 / 11 = 6.55 | 7 years |
| 12% | 72 / 12 = 6 | 6 years |
This table shows how the Rule of 72 gives a good approximation across different interest rates and investment returns for how long it takes an investment to double. The approximation gets less accurate at very low and very high compounding rates.
How the Rule of 72 Formula Can Change Your Life
The Rule of 72 formula can change your life in crucial ways if you understand the power and opportunity to grow capital through returns over time. I was inspired to start saving and investing capital at 18 years old after I saw my first compounding growth table for money in an investment brochure. It changed my life as it taught me the importance of putting capital to work, either earning interest or in the stock market, to grow wealth to change my financial life over time. The Rule of 72 is a condensed, easy-to-understand version of the table I first saw.
This power of compounding is what Warren credits as making him wealthy.
“My wealth has come from living in America, some lucky genes, and compound interest.” – Warren Buffett.
Here is what the Rule of 72 can teach you by looking at the growth charts above:
- It shows the power of compound interest and how your money can grow exponentially over time. Even if growth seems slow initially, compounding will accelerate it over decades. This highlights the importance of starting to invest early.
- It demonstrates how earning consistent high returns from stocks or lower interest from bonds, makes an enormous difference over time. This emphasizes the value of investing in owning assets rather than just borrowing money to buy depreciating consumer goods.
- Seeing the math of long-term growth can motivate you not to give up, even if your portfolio and capital seems small. Consistent contributions and compounding will eventually result in exponential growth.
- Knowing this formula allows you to easily explain and demonstrate the power of compounding to others. You can motivate and educate family and friends to start investing early and earn higher returns by showing them how the Rule of 72 works.
- It provides mathematical proof that creating positive returns from investing or trading and letting compounding work over decades is critical to building wealth rather than trying to just earn a high salary by selling your time to an employer.
The Rule of 72 gives mathematical clarity to the most critical personal finance principles of starting early, investing, earning higher returns, and the power of compound interest. This formula and its lessons can transform your investing mindset and financial future.
Key Takeaways
- The Rule of 72 provides a simple way to calculate doubling time for an investment based on its interest rate. Just divide 72 by the rate of return to get the approximate number of years to double your money.
- Starting investing early is crucial, as the doubling effect of compound interest accelerates exponential growth over time. Don’t let regret over not beginning sooner prevent you from starting now.
- Focus on owning assets that generate consistent higher returns rather than conservative or speculative investments. This amplifies the power of compounding to build your wealth over decades.
- Consistency and patience are key. Even if growth seems slow initially, continuing to invest allows compounding to work its magic long-term.
- Use the Rule of 72 to educate and motivate others. Demonstrate the extraordinary power of lifelong compounding.
Conclusion
The Rule of 72 provides a precise mathematical understanding of how lifelong investing, earning higher returns, and the exponential power of compound interest can transform your finances. While growth may seem stagnant in the early years, consistency and endurance can pay off enormously over decades. This formula highlights the most critical principles of personal finance – start early, keep investing, earn higher returns, and let compounding grow your money. Learning and applying the Rule of 72 can change your financial future and mindset about the key to investing success forever.