The Power Of Compounding: Doubling Your Investment In A Decade

The Rule of 72 is a quick and useful formula that can be used to estimate how long it will take for an investment to double in value. It is based on a fixed annual rate of return and can be applied to any investment size or rate of return. By dividing 72 by the expected annual rate of return, investors can determine the number of years it will take for their initial investment to double. For example, with a 10% annual return, it will take approximately seven years for an investment to double. The Rule of 72 is a simplified version of the future value formula and is most accurate for rates of return between 6% and 10%.

The Rule of 72

It is important to note that the Rule of 72 does not factor in losses or changes in the rate of return over time. Additionally, it does not account for the impact of inflation, taxes, or investment fees on investment returns. For more precise outcomes, the Rule of 69.3 or the Rule of 70 can be used, although the calculations are more complex.

Stocks vs savings accounts

Savings accounts and stocks are two very different financial tools, each with its own advantages and disadvantages. Here are some key points to consider when deciding between the two:

Savings Accounts

Savings accounts are ideal for preserving your money and providing easy access to funds in the short term. They are a safe and secure option, as your money is protected by FDIC insurance, and you can withdraw it at any time without penalties. Savings accounts are a good choice for emergency funds or expenses that you plan to incur within the next three to five years, such as a home down payment or unexpected emergencies. While the returns on savings accounts are generally low and may not keep up with inflation, they provide a predictable and stable option for your money.

Stocks

Stocks, on the other hand, are a tool for growing your money over the long term. Historically, the stock market has provided an average annual growth rate of about 7% after inflation, and broad market index funds can provide access to this market-level growth. Stocks are a good choice for funding long-term goals, such as retirement, and for building generational wealth. However, investing in stocks comes with higher risk and volatility. The value of stocks can fluctuate significantly, and there is no guarantee of returns. Additionally, investing in stocks may come with penalties or taxes for early withdrawal, and it may take several years to see a profit.

Rule of 72

The Rule of 72 is a shortcut to estimate how long it will take for your money to double based on a fixed annual rate of return. By dividing 72 by the expected annual return, you can determine the number of years needed to double your initial investment. For example, with a 10% annual return, it will take a little over seven years to double your money. This rule can be applied to both savings accounts and stocks to get a general idea of their growth potential.

In conclusion, both savings accounts and stocks have their advantages and are important tools for achieving financial security. Savings accounts are ideal for preserving capital and providing liquidity for short-term goals, while stocks offer the potential for higher returns over the long term. The right choice depends on your financial goals, risk tolerance, and time horizon.

Historical asset returns

The Rule of 72 is a formula used to estimate the number of years required to double an investment at a given annual rate of return. It is calculated by dividing 72 by the expected rate of return. For example, if an investment has a 6% annual rate of return, it will take 12 years for the investment to double (72/6=12). The Rule of 72 is reasonably accurate for interest rates between 6% and 10%.

Historical data can be used to make an educated guess about future returns. For example, according to Standard and Poor's, the average annual return of the S&P 500 index from 1926 to 2020 was 10%. At this rate of return, an investment would double every seven years (72/10=7). However, it is important to note that past performance does not guarantee future results, and stock prices can be volatile.

To get a more accurate estimate of how long it will take an investment to double, it is necessary to consider the specific asset class and historical returns for that asset class. For example, consider the following asset classes and their historical returns over the past 15 years:

• Large Cap Stocks – S&P 500 Index
• Small Cap Stocks – Russell 2000 Index
• International Developed Stocks – MSCI EAFE Index
• EM Stocks – MSCI Emerging Markets Index
• REITs – FTSE NAREIT All Equity Index
• High Grade Bonds – Bloomberg Barclays U.S. Agg Index
• High Yield Bonds – ICE BofA US High Yield Index
• Cash – S&P U.S. Treasury Bill 0-3 Mth Index

By considering the historical returns for these asset classes, investors can make more informed decisions about where to allocate their investments to achieve their financial goals. However, it is important to remember that diversification can help smooth out short-term swings and reduce the risk of huge losses.

Pros and cons of the Rule of 72

The Rule of 72 is a simple formula to estimate how long an investment will take to double, given a fixed annual rate of interest. It is calculated by dividing 72 by the annual rate of return. The Rule of 72 is not precise, but it is a quick way to get a useful ballpark figure.

Pros of the Rule of 72

• It is a simple formula that is easy to calculate and comprehend, even for beginners.
• It is a quick way to get a rough estimate of how long it will take for an investment to double.
• It can be used to estimate the rate of return needed for an investment to double in a given period.
• It can be applied to anything that grows at a compounded rate, such as population, macroeconomic numbers, charges, or loans.
• It can also be used to understand the impact of fees and inflation on investments.
• The number 72 has many convenient factors (1, 2, 3, 4, 6, 8, 9, and 12), making it easier to use for mental calculations.

Cons of the Rule of 72

• It is not perfectly accurate, especially for interest rates outside the range of 5% to 10%.
• It is only an estimate and does not take into account past market results or future market behaviour.
• It may not be suitable for investments with a variable rate of return, such as stocks.
• It does not consider the impact of additional contributions or withdrawals on the investment.
• It does not account for taxes, fees, or other factors that may affect the actual rate of return.

The Rule of 72 in practice

The Rule of 72 is a simple formula that estimates the number of years required for an investment to double based on a given annual rate of return. It can also be used to calculate the annual rate of compounded return from an investment given the number of years it will take to double.

The Rule of 72 is calculated by dividing 72 by the annual rate of return (or the rate of interest) to get the number of years it will take for the investment to double. 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.

The Rule of 72 is a useful "back-of-the-envelope" method for estimating how long an investment will take to double. It is often taught to beginner investors as it is easy to understand and calculate. However, it is important to note that the rule is a simplification of a more complex logarithmic equation and provides only an approximate timeline.

For more precise outcomes, the Rule of 69.3 or the Rule of 70 can be used, which are more accurate but less convenient for mental calculations. The Rule of 72 is most accurate for rates of return between 6% and 10%.

The Rule of 72 can also be applied to anything that increases exponentially, such as GDP or inflation, or to calculate the long-term effect of annual fees on an investment's growth. For example, if the gross domestic product (GDP) grows at 4% annually, the economy will be expected to double in 72 / 4% = 18 years.

Additionally, the Rule of 72 can be used to estimate the rate of return needed for an investment to double given a specific investment period. For instance, if you want to double your money in eight years, divide 72 by eight, which means you will need an average annual return of 9%.

The Rule of 72 is a handy tool for investors to quickly estimate how long their investments will take to double or what rate of return they need to achieve their investment goals.

Frequently asked questions