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What is a Rule of 72?
What’s important to know about it?
In this article, I will break down the meaning of Rule of 72 so you know all there is to know about it!
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Let me explain to you what Rule of 72 is and why it’s important!
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What Is Rule of 72
The Rule of 72 refers to a quick formula that is used to determine how long it would take for you to double your investment at a given annual rate of return.
You can also use the Rule of 72 to determine the rate of return that you need on your investment depending on the number of years you are looking double your investment.
By using the Rule of 72, you’re looking to quickly calculate how long it would take for your investment to double without having to take out a computer or calculator for a precise calculation.
The idea is that most people should be able to mentally use the Rule of 72 to get a quick and ballpark idea of the result.
Of course, if you wish to know exactly how long it would take for you to double your money at a given rate of return, a calculator will be necessary at that point.
Keep reading as I will break down how you can calculate Rule of 72 and how it works.
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When To Use Rule of 72
The Rule of 72 is used to calculate compounded interest rates.
In other words, you can use it to calculate things that can increase exponentially over time, such as inflation.
You should also use the Rule of 72 in situations where the exponential rate of return is somewhere between 6% to 10%.
For rates of return below 6% and over 10%, your result will not be as accurate.
This rule is often used by investors, business owners, financial analysts, traders, or other investment professionals to quickly calculate how long it may take an investment to double at a given rate.
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Rule of 72 Formula
You can use the Rule of 72 in two different ways: to calculate how long your investment will double at a given rate, or to calculate the rate of return you need to double your investment in a given period.
To calculate how long it will take for your investment to double, you can use the following formula:
Years To Double Investment = 72 / Annual Rate of Return
This means that you need to divide 72 by the expected annual rate of return to see how long it will take for your investment to double.
For example, if you want to know how long it will take to double your investment with an 8% return, divide 72 by 8.
Now, to calculate the annual rate of return that you need to double your investment in a given period of time, you can use the following formula:
Annual Rate of Return = 72 / Years To Double Investment
In other words, by dividing 72 by the number of years you want to double your investment, you will get the annual rate of return that you need.
For example, if you want to double your investment in 4 years, divide 72 by 4 and you’ll get 18.
This means that you’ll need an 18% annual rate of return over 4 years to double your investment.
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Rule of 72 Interpretation
The Rule of 72 is quite easy to calculate and use.
You can either calculate how long it will take for your investment to double or lose half its value based on a fixed annual rate of return or you can calculate the fixed rate of return you need to double or half your investment value over a fixed period of time.
When you’re calculating how long it takes to double your investment, the Rule of 72 will provide you the number of periods or years it will take for the investment to double.
For example, if I’m looking at an investment with a 10% annual return, I can quickly calculate that it will take me 7 years to double my investment (72 / 10 = 7).
When you’re looking to calculate the rate of return based on a fixed period of time, Rule 72 will tell you what rate of interest you need over the fixed period to double your investment.
For example, if I want to double my investment over a 6-year period, I can quickly calculate that it will need a 12% annual rate of return (72 / 6 = 12).
Keep in mind that the “Rule of 72” is not scientifically accurate but is a great approximation.
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Rule 72 Examples
Let’s look at a few examples of how Rule 72 can be used in real-life.
The first example is when a young investor is looking to quickly calculate the value of his or her investment over a 30-year period.
If the investor knows that the investment value is $25,000 and the average rate of return over the next 30 years is 10%, then he or she can expect the investment to double 4 times.
We start by taking the Rule of 72 to see how long it takes the investment to double (we’ll do 72 / 10 = 7 years).
Since it will take 7 years for the investment to double, in the course of the next 30 years, there are at least four 7-year cycles.
Roughly speaking, the investment will double four times going from $25,000 to $50,000, to $100,000, to $200,000 and finally to $400,000.
In the second example, let’s look at how inflation can chip away at your purchasing power over time.
Let’s assume that inflation is 6%, then we’ll do 72 / 6 = 12.
This means that your purchasing power will be reduced by half over the course of the next twelve years if inflation remains at 6%.
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So there you have it folks!
What does the Rule of 72 mean?
In a nutshell, the Rule of 72 is a quick way for you to determine how long it will take you to double your investment based on a fixed annual rate of return.
The main objective here is to get an approximate value.
If you’re looking for a mathematically precise figure, then it’s best to use a calculator.
The Rule of 72 is simple enough that anyone can mentally calculate the result.
This rule is used when calculating things that may grow or decrease at an exponential rate, such as compounded rate of return, inflation, or GDP.
Now that you know what Rule of 72 is all about and how to calculate it, good luck with your research!
I hope you enjoyed this article on Rule of 72! Be sure to check out more articles on my blog. Enjoy!
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