In The News

Mon 18 Jun 2018

The Rule of 72


Finance & Insurance
The Rule of 72 is a simple mathematical rule that I learned from a Noel Whittaker* book I read early in my professional career.

Simply explained, the Rule of 72 helps you quickly work out how long it will take for an investment to double at any given rate of return.

 

It can also be used to work out the effect of inflation on savings.

I use the Rule of 72 regularly. I’m sharing it with you because it is not well known.

To determine the length of time for an investment to double divide the number 72 by the expected rate of return.

Eg. if you expect your house will increase in value by 5% per year on average, then its value will double in just over 14 years (72/5).

So if your home is worth $600,000 now, it will be worth $1.2 million in 14 years if the average growth rate is 5% per year.

If the average growth rate is 3% per year then your $600,000 house is worth $1.2 million in 24 years (72/3)

To determine the effect of inflation on savings divide 72 into the expected inflation rate.

Eg if you have $100,000 saved for retirement and you expect inflation to be 2% per year then after 36 years (72/2) that nest egg will only have the purchasing power of $50,000 in today’s money.

The Rule of 72 can be used to quickly assess the merits of (especially unsolicited) investment advice.

For instance, if a friend or colleague were to discuss an investment they’ve made which promises an investment return of 10% per year (on an initial investment of $50,000) you can quickly calculate that, if true, your money will double every 7.2 years at that rate (72/10):

Investment today.                      $50,000
Investment value in 7 years.    $100,000
Investment value in 14 years.  $200,000
Investment value in 21 years.   $400,000
Investment value in 28 years.   $800,000

These figures are correct on the assumption of a continued annual average rate of return of 10% per annum.

By doing this exercise you can appreciate the value of compounding. You should also appreciate and expect that the 10% investment return per year suggested by your friend or colleague is not likely. Instead, the average rate of return over the term of the investment may be far less.

The Rule of 72 works. It is simple and assumes a constant or average rate over time.

Feel free to use it as a guide.

Grant

 

*Australian personal finance expert and author of ‘Making Money Made Simple’ and many other bestselling books and articles

 


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