The ‘Rule of 72’ is a quick calculation which takes into consideration the effect of annual compound interest assuming no additional investment or withdrawals.
It’s as simple as taking the anticipated interest rate and dividing it into 72. So if you expect a return of 8%pa then as 72 divided by 8 equals 9, it will take 9 years to double your money.
Let’s use an example: Jim is 35 years old and has $50,000 in savings. He invests this money in an account offering 6%pa return. According to the Rule of 72, it will take Jim 12 years to double his money so at age 47 he would have $100,000 in the account.
You can also use the Rule of 72 to work out the interest rate needed to double your money in a certain period. To do this, you need to divide 72 by the number of years that you wish to double your money in.
Using our previous example: Jim decides he wants to double his money in 10 years, not 12. Using the rule of 72, he divides 72/10 and works out that he will need a return of 7.2%pa in order to double his money.
The chart below compares the numbers given by the rule of 72 and the actual number of years it takes an investment to double.
|Rate of Return||Rule of 72||Actual # of Years||Difference (#) of Years|
‘Of course different kinds of investments provide different kinds of return – such as income, growth or both. With the Rule of 72 it assumes we are receiving growth only or that income is fully reinvested. So for an investment property it is difficult to reinvest the rent you receive – to gain the benefits of compounding. With investments such as a term deposit, shares or managed funds it might be much simpler to reinvest the income component.
Another area to consider is taxes. We have shown you what an investment might be worth after a period of time, however it does not take into account taxes. This will be specific to your personal circumstances, and also depend whether the investment is held in your personal name verses your superannuation fund, for example. Tax might make a large difference to your investment outcome. You will also be taxed differently on income verses capital gains, as in this example. You may or may not be into ‘Social Media’ – it is another good example of the power of compounding, watch this video.