The Magic Of Compounding: Unlocking The Secret To Doubling Your Investments

The Rule of 72 is a quick and easy method for determining how long it will take for an investment to double in value, based on its rate of return. It is a simplified formula that can be used for mental calculations to quickly gauge an approximate value. The rule states that to calculate the number of years it will take for an investment to double, you divide 72 by the expected rate of return. For example, if an investment scheme promises an 8% annual compounded rate of return, it will take approximately nine years (72 / 8 = 9) to double the invested money.

The Rule of 72

For example, if an investment scheme promises an 8% annual compounded rate of return, it will take approximately nine years (72 / 8 = 9) to double the money invested. This calculation is based on an average rate over the life of the investment.

Additionally, the Rule of 72 can be adjusted for higher accuracy. The number 72 can be modified based on the specific interest rate. For instance, using 69 or 70 for very high or low rates will provide a more precise estimate.

Historical returns

The Rule of 72 is reasonably accurate for interest rates that fall in the range of 6% and 10%. It is a useful rule of thumb, especially for beginner investors, as it is easy to understand and calculate.

However, it is important to note that the Rule of 72 is not entirely precise. For more accurate results, you can divide 69.3 by the rate of return. While this calculation may be more cumbersome, it provides a more accurate estimate.

Historical data can be used to make educated guesses about how long it will take for an investment to double. For example, according to Standard and Poor's, the average annualized return of the S&P index, which later became the S&P 500, from 1926 to 2020 was 10%. At 10%, you could expect to double your initial investment every seven years (72 divided by 10). On the other hand, a less risky investment, such as bonds, which have averaged a return of about 5% to 6% over the same period, would take approximately 12 to 14 years to double your money (72 divided by 6 or 5).

Data from NYU Stern shows that the S&P 500 has doubled about 10 times since 1949, illustrating the power of long-term investing. During this period, the value of $100 invested in real estate assets would be worth $5,121.52, while the value of $100 invested in the S&P 500, including reinvested dividends, would have reached over $624,000.

It is important to remember that past performance does not guarantee future results, and the Rule of 72 should be used as a guideline rather than an exact prediction.

Inflation

The Rule of 72 is a formula that calculates how long it will take for an investment to double in value based on its rate of return. It is calculated by dividing 72 by the expected rate of return. For example, if an investment scheme promises an 8% annual compounded rate of return, it will take approximately nine years (72 / 8 = 9) for the initial investment to double.

The Rule of 72 is a simplified formula that provides a reasonably accurate timeline. It is most accurate for rates of return between 6% and 10%. For rates outside this range, the rule can be adjusted by adding or subtracting 1 from 72 for every 3 points the interest rate diverges from the 8% threshold.

The Rule of 72 can also be used to calculate the rate of return needed for an investment to double given a certain investment period. For example, if your goal is to have $1 million by age 65 and you are currently 35, you know you have 30 years to reach that goal. Based on the rule of 72, you would need to earn 2.4% to double your money in 30 years (72/R = 30, where R is the rate of return).

The Rule of 72 can also be used to understand the impact of inflation on investments. Inflation has averaged 3.3% over the last century. If a 4% positive return doubles your money in 18 years, a 4% annual inflation rate will halve the value of your investments over the same period. If inflation is 2% instead of 4%, it will take 36 years for your money to be reduced by half.

While the Rule of 72 is a useful tool for investors, it has some limitations. It is based on the assumption of a constant rate of return each year, which may not reflect reality. It also does not account for losses or changes in the rate of return each year, and it does not factor in inflation or tax rates, which can significantly impact investment returns.

Investment fees

The Rule of 72 is a formula used to estimate how long an investment will take to double an initial sum of money based on a fixed annual rate of return. It is calculated by dividing 72 by the fixed rate of return, giving the number of years it will take for the initial investment to double. For example, an investment with a 6% annual return will double in 12 years, and an investment with a 10% annual return will double in a little over seven years.

While the Rule of 72 is a useful shortcut, it is important to remember that it does not account for investment fees, which can have a major impact on investment growth over time. Investment fees are charged for the use of financial products and services, such as broker fees, trading fees, and expense ratios. These fees can vary depending on the type of investment and the service provider.

When considering investment fees, it is essential to ask questions such as:

• What are the total fees to purchase, maintain, and sell this investment?
• Are there ways to reduce or avoid certain fees?
• How much does the investment need to increase in value before breaking even?
• What are the ongoing fees to maintain my account?

By understanding and comparing the fees associated with different investment options, investors can make more informed decisions and maximise their returns over time.

• Ongoing fee of 0.25%: $10,000 grows to $19,140
• Ongoing fee of 0.50%: $10,000 grows to $18,570
• Ongoing fee of 1%: $10,000 grows to $17,240

As demonstrated, higher fees result in lower overall returns, which can significantly impact an investor's portfolio value and their long-term financial goals. Therefore, while the Rule of 72 is a handy estimation tool, it is crucial to consider the role of investment fees when planning for the future.

Stocks vs savings accounts

The Rule of 72 is a formula used to estimate how long it will take for an investment to double. It is calculated by dividing 72 by the expected rate of return. For example, if an investment scheme promises an 8% annual compounded rate of return, it will take approximately nine years (72 / 8 = 9) to double the invested money.

Now, when it comes to stocks vs savings accounts, both are important concepts for building financial stability, but they serve different purposes. Here are the key differences and considerations:

Savings Accounts:

• Level of Risk: Savings accounts typically offer lower returns but with minimal risk. Your money is guaranteed by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor in an FDIC-insured bank.
• Liquidity: Savings accounts offer high liquidity, meaning you can access your funds quickly when needed. However, you may incur penalties for early withdrawals from certificates of deposit (CDs).
• Returns: Savings accounts provide lower returns compared to investing, and the spending power of your cash may decline over time due to inflation.
• Fees: Savings accounts usually have minimal fees, such as maintenance or Regulation D violation fees for more than six transactions per month.
• Ease of Use: Saving is generally straightforward and doesn't require a steep learning curve.
• Ideal for: Short-term financial goals, emergency funds, and when you need access to your money within the next few years.

Stocks:

• Level of Risk: Investing in stocks offers the opportunity for higher returns but comes with a higher risk of loss.
• Liquidity: Stocks are generally liquid and can be converted into cash on weekdays. However, it's important to let your investments stay in the market for at least five years to ride out short-term fluctuations.
• Returns: Stocks have the potential for much higher returns over the long term. Historically, the Standard & Poor's 500 stock index (S&P 500) has returned about 10% annually.
• Fees: Brokerage accounts may have higher fees, but many brokers now offer free trades.
• Complexity: Investing can be complex and requires research, especially when compared to the relative simplicity of saving.
• Ideal for: Long-term financial goals, such as retirement, when you can tolerate the ups and downs of the market, and when you won't need access to the funds in the near future.

In summary, saving is generally safer and more suitable for short-term goals, while investing offers higher return potential but with higher risk. It's important to consider your financial goals, risk tolerance, and time horizon when deciding between stocks and savings accounts.

Frequently asked questions