Though it can seem like an oversimplification, one of the most fundamental ways to make investment projections is to know how long it will take the value of that investment to double. After all, if you don’t know at least that much, any other projections are of very limited value.
Fortunately, there’s a simple rule of thumb – the Rule of 72 – that’s been used for this purpose for centuries. By using a single, simple calculation, you can learn how long it will take for an investment earning a certain rate of return to double in value.
And if you’re investing over several decades, you can calculate how long it will take for your initial investment to double, and then to double again after that. In fact, you can use the Rule of 72 for as many investment timeframes as you have in your life. That makes the rule particularly appealing when calculating the future value of retirement portfolios and other long-term investment accounts.
What is the Rule of 72?
The “Rule of 72” – sometimes referred to as the “accountant’s Rule of 72” – is the amount of time required to double your money. This can be estimated by dividing 72 by your rate of return.
The rule can be used in one of two ways:
- To determine the rate of return you’ll need for your investment value to double.
- To estimate how long it will take for an investment to double at a given rate of return.
Let’s work examples showing how the Rule of 72 works for each calculation.
You want to know what rate of return you’ll need to earn to double a $10,000 investment. By dividing 72 by $10,000 by 72, you’ll get 7.2%. That’s the return you’ll need to earn on your investment to double its value in 10 years.
You can prove that by calculating the value of $10,000 invested at 7.2% after 10 years. The value will be $20,042. That’s pretty close for an estimate, wouldn’t you say?
You want to invest in an interest-bearing investment paying 3% per year, and you want to know how long it will take for that investment to double. By dividing 72 by 3%, you’ll get 24. That means it will take 24 years for your investment to double.
You can prove that by calculating the value of $10,000 invested at 3% over 24 years. The value will be $20,328. That’s a bit over the doubling mark, but I’m sure you won’t have a problem with that.
As you can see from the two examples above, the rule is approximate. In each case, the return was slightly greater than double the original investment. But it can also work in the other direction. Under certain scenarios, doubling your money may require a slightly higher interest rate or longer term than the rule of 72 would indicate.
That means the rule of 72 is, at best, a rough approximation. But it comes close enough to doing the job that it’s accepted as a general rule of thumb in the financial industry.
How can you put the Rule of 72 into practice?
The rule of 72 works best with long-term investment accounts, especially retirement accounts. Not only do retirement accounts involve investing for several decades, putting investment return averages in your favor, but they’re also tax-deferred. By removing annual tax liabilities, you’ll get the benefit of your full investment return each year.
Let’s say you’re holding a retirement account within an investment brokerage platform. I’ll use E*TRADE as an example, since they provide commission-free trading of stocks, options, and exchange-traded funds (ETFs), as well as investments in mutual funds and bonds. And if you don’t feel like engaging in self-directed investing, they also offer several managed portfolio options that can provide reasonably predictable returns.
So, let’s say you open an account – perhaps an IRA – on E*TRADE. You choose to invest 70% of your portfolio in stocks and 30% in fixed-income investments.
Historically, stocks have averaged returns of about 10% on a yearly basis. If 70% of your portfolio is invested in stocks, you can expect an average annual return of about 7% on your overall portfolio from the stock portion.
Bonds and other fixed-income investments are a little more tricky because of low interest rates. But let’s assume you can expect to average 1% per year going forward. That would contribute a 0.3% annual return on your total retirement portfolio (30% x 1%).
Combined, you’ll have an average annual rate of return of 7.3%. That’ll be comprised of a 7% portfolio return on your stock positions, and a 0.3% contribution from your bond investments.
By dividing 72 by 7.3%, you’ll see that your money will double in about 9.86 years.
Putting the Rule of 72 into practice over several decades
Let’s make a few assumptions and see how the rule of 72 applies. Let’s say you move $100,000 from the 401(k) plan of a previous employer into a traditional IRA. You’re 35 years old, and you want to know what the money will be worth when you retire in 30 years. I’ll assume the 7.3% average annual rate of return determined above and use round numbers for the results.
Here’s what I get:
|Time frame||Portfolio value at the end of each decade|
Since your portfolio value will double every 10 years, it’ll increase by a factor of eight – all the way to $800,000 – after 30 years
There is one important caveat here. It’s been assumed that you’re projecting investment returns on a fixed retirement portfolio balance. But in most cases, you’ll be making annual contributions, which will largely invalidate the use of the rule of 72. If you’re trying to make projections on an actively funded retirement plan, the better choice will be to use a retirement calculator (like the one below) to figure out where you’ll be by the time you retire.
What are the downsides of the Rule of 72?
Probably the biggest single downside of the rule of 72 is that it works primarily with lower numbers. In the examples given at the beginning, the rates of return are all in single digits. But the rule is much less accurate with higher numbers.
For example, let’s say you expect an investment to produce a 24% rate of return. Based on the rule of 72, your investment would double in just three years (72 ÷ 24 = 3).
In reality, a $10,000 investment earning 24% per year for three years, will grow to $19,066.
The situation will be even more pronounced with an assumed rate of return of 36%. Though that return would suggest doubling your investment in just two years (72 ÷ 36 = 2), it will actually miss the mark. After two years, your investment will grow to $18,496.
That’s a pretty big miss.
Another downside is attempting to use the rule of 72 based on current interest rates on safe investments. The current national average interest rate on savings accounts is just 0.05%. If you’re trying to use the rule of 72 to figure out how long it will take your money to double at that rate, the situation will be pretty hopeless. It will take you several centuries to double your money at 0.05%.
You can improve that situation significantly by investing in a high-yield savings account. There are some available to pay interest rates as high as 1%. At that rate, you’ll be able to double your money in 72 years, which is at least well within a human lifetime.
Who should use the Rule of 72?
Back when fixed income investments reliably paid interest rates by 5%, 6%, 7%, and more, the use of the rule of 72 made abundant sense. After all, if you could invest in a CD paying 6%, a quick application of the rule of 72 would show you that your money would double in just 12 years (72 ÷ 6 = 12).
The rule of 72 worked very well with those high-interest rates. Those rates are long gone, but if they ever return the rule will come back into play.
But where the rule of 72 may work best is with long-term investors, particularly those investing for retirement. You’ll have plenty of decades to project, and rates of return on stocks tend to be much more predictable over terms of 20 years or more.
Who shouldn’t use the Rule of 72?
If you’re trying to project the future value of your retirement assets, and you’re just a few years from retirement, the rule of 72 may not have much value.
For example, if you plan to retire in five years, and expect to earn an average annual return of about 7% on your portfolio – which will take just over 10 years to double – the rule of 72 won’t be of much value. That’s because you’ll begin accessing the funds long before they double in value.
It will also be virtually impossible to use the rule of 72 if your future investment returns can’t be accurately predicted.
For example, let’s say that you participate in short-term trading, especially day-trading. That’s become more popular in an era of online trading since you can literally move in and out of positions on the same day.
The rise of trading apps, like Robinhood, which specifically caters to day traders and other short-term traders, has also made high-frequency trading more popular. Robinhood charges no trading commissions and is designed specifically as a mobile app where you can trade on the go.
Though it is possible to make higher returns on short-term trading, the annual rate of return is completely unpredictable. It may be a 10% one month, then down 5% the next. In addition, as a day-trader, you’ll be focused primarily on short-term gains, rather than long-term projections. Tools like the rule of 72 may have very little practical value for short-term traders.
Other situations where the Rule of 72 could work against you
Though it’s a useful tool for making investment projections, the simplicity of the formula might cause you to become overly aggressive with your investments.
For example, upon learning you can double your money in just over seven years with a 10% average annual return, you may become overly aggressive with your portfolio. You may forgo bonds and other fixed-income investments in favor of an all-stock portfolio. That’s the kind of portfolio that would be necessary to produce annual double-digit returns.
But if your timing is bad, and the market goes against you, the rule of 72 will go right out the window – fast. And since you will not have diversified into safer investments, you’ll be fully exposed to the downside risk of your stock positions.
Put another way, stocks may provide higher returns than fixed-income investments, but they don’t hold with the mathematical precision of projections of rules of thumb, like the rule of 72.
You may also want to avoid using the rule of 72 if you’re looking for precise calculations. As shown in the examples earlier, the rule doesn’t entirely hold up with higher investment returns. Though the rule of 72 will give you an approximation, a more precise projection can only come about through the use of mathematical calculations or a good investment calculator.
Is the rule of 72 a 100% accurate way to project the future value of an investment? No, but that’s not its true purpose. The reason to be aware of the rule and to put it into practice is so that you’ll have a simple approximation of how long it will take your investment to double.
You’ll need to use an investment or retirement calculator to get a completely precise number. But the rule of 72 can get the job done when a calculator isn’t available. All you need is the rate of return on your investments and a calculator – which you probably have on your smartphone.
In the entire investment universe, the rule of 72 may be the simplest calculation there is.