Why 72 Is a Magic Number for Your Money
The world of investing can be confusing even for seasoned players, but one simple number can make it easy to predict how your money might grow over time.
It’s known as the rule of 72, a formula that can help you simplify complex financial projections, make informed decisions about potential investments and predict the long-term outcomes of those investments years from now.
While there is no such thing as an investing magic number, money grows at predictable rates over time when interest rates are defined — that’s where the rule of 72 comes in. Let’s examine it more closely.
Use It To Project Investment Growth
Investors can use the rule of 72 to quickly determine how many years it will take to double their money depending on the yields they earn on their investments. Just divide the number 72 by the interest rate.
For example, if an investment pays 8% interest, it will take nine years to earn a 100% gain because 72 divided by eight is nine. It’s important to note that the formula only works if you use the interest rate as a whole number, like 8, not a decimal out of one, like 0.08.
Use It To Find an Interest Rate That Matches Your Goals
The rule of 72 can work in the other direction, too. Instead of using a defined interest rate to learn how long it will take to double your money, you can use a specified time horizon to identify the interest rate you’ll need to earn in order to reach your goals.
In this case, you’ll divide 72 by the number of years in your plan.
For example, if you need to double your money from $250,000 to $500,000 to retire early in seven years, divide 72 by seven for a result of roughly 10.29. In order to meet your retirement goals, you would need to put your money into an investment that delivers a return of 10.29%.
The Rule Can Help You Prepare For Inflation
You can also use the rule of 72 to find out how many years it will take for inflation to reduce your money’s buying power by half. The process is similar — just divide 72 by the inflation rate. Today, the rate of inflation is roughly 8%, which means your money will be worth half as much as it is today in nine years if nothing changes. At the ideal inflation rate of 2%, it would take 36 years.
Limitations of the Rule of 72
It’s not just interest and inflation. You can use the rule of 72 to calculate anything that compounds your principal, like reinvested dividends. But it’s not perfect and should be used only as a general guide — and the formula does have very specific parameters and some limitations.
For example, the rule of 72 works only with compound interest, not simple interest, and it’s reasonably accurate only for interest rates between 6%-10%, with 8% being the sweet spot. The farther you diverge in either direction, the less reliable the formula becomes. Still, it can be a very useful tool for your finances.
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