For a long time, the Rule of 72 has been an investor’s best friend. Although we now live in a world of super accurate algorithms, personal spread sheets, and handy online calculators, the Rule of 72 is still useful as hell when you need to make a quick mental calculation about the value of your investments.
The Rule of 72 allows you to calculate how long it will take for your investments to double at a fixed interest rate.
We’ve already discussed the wonders of compound interest and how it’s one of the greatest forces in the universe along with duct tape. Trying to calculate it on the fly though can be a tricky business. That’s where the Rule of 72 comes in.
The calculation itself is relatively simple. This is because it is actually only an estimate calculation. The original, far more complicated calculation, is difficult to do in your head. However, by substituting the number 72 you are guaranteed to get an accurate estimate (up to an interest rate of around 25%) and so, the Rule of 72 was born.
The only piece of information you need is your compound interest rate. Once you know that just plug it into the below formula:
In real terms
This means that if your grandmother gives you £1,000 for your birthday, and you decide to put it in a compound interest account with an interest rate of 8% your money will take 9 years to double to £2,000.
72 / 8% = 9
Then, 9 years later it will double again to £4,000, and so on.
Why is this useful?
Being able to easily calculate the worth of your portfolio at certain points down the line is incredibly useful. If you are saving for the future, either for retirement or a big purchase like a house, then this formula gives you an idea of exactly what you need to save and the interest rate you need to be saving at in order to reach your target.
For example, let’s say you’re saving to buy a house and you want to be able to buy in 10 years. This calculation gives you an idea of what interest rate you need to be looking for in order to make that happen. You just need to invert the calculation:
72 / 10 years = an interest rate of 7.2%
By figuring this out from the outset you can search for the optimum interest rate. You can also make more meaningful choices in the mean time for the type of house you can afford and the alterations you need to make to your current lifestyle to maximise your earnings.
This quick calculation allows you to create a more targeted savings and investment plan. The best way to achieve a large-scale goal is to work up to it in smaller stages. Without being able to envision the end goal clearly it is much more difficult to get it done. The more details you have at your disposal the more accurate your approach can be.
Your capital is at risk, and past performance may not be a reliable indicator of future results. Oval Money is not permitted to provide financial advice, and if you have any questions please consult an expert.