Investors are always looking for large returns. The question is, how do we find them? Roulette, call and put options, the next Patriots game’s spread - these are all ways in which someone can lose their money in hopes of hitting the gold mine. The truth is, there is a way to get these extraordinary returns. The cost is time. With enough time and compound interest on your side, those returns will blow you away. The question becomes, how much time. We arrive at this answer with the Rule of 72. This is a quick formula that tells you how many years it takes to double your investment. It is as simple as dividing 72 by the expected rate of return of the investment.
Let’s use the historical S&P 500 for an example. If we were to assume a 10% rate of return (about how well the S&P has performed in the past 100 years), we take 72/10. With this, we learn that the investment will double in 7.2 years assuming we estimated the rate of return correctly.
72 / 10 = 7.2
In another example, lets pretend someone purchases a Certificate of Deposit with an interest rate of 4%. How would we calculate this rate of return?
72 / 4 = 18 years for the investment to double
Even an extremely favorable return of 10% won’t double your money overnight, but this is how wealth is created. The earlier you get serious about investing, the more time you have to double your wealth over and over.
Although the formula is rudimentary, it is used as a wonderful teaching tool to explain the power of compound interest. It also adds motivation, as you understand that every dollar you invest can turn into many dollars in the future. We don’t use it as an assumption in a financial plan, as actual returns fluctuate. Even as a financial advisor, though, I use the Rule of 72 when making mental calculations. Before making any big purchase, rewire your brain to think about the Rule of 72 and how much you could earn by holding off and investing instead.