The Rule of 72 is a very simple financial short-cut: divide your rate of return into 72 and you have (approximately) the number of years it takes for your money to double.
Double Your Money
2% = 36 years
4% = 18 years
6% = 12 years
8% = 9 years
This gives you an idea of the importance of compounding. But aside from being a way to impress children and small animals with your math prowess, is there a practical application of the rule of 72? Yes, there are a number of ways that thinking about The Rule of 72 can improve our behavior and give us better financial outcomes with our investing. For example:
1) Think Long-Term. Think in terms of “doubling periods”. If you are targeting a 7% rate of return, your doubling period would be 10 years. If you have 20 years until retirement, you would expect your money to double twice. If you have $200,000 today, you should have $800,000 in 20 years, in this hypothetical scenario. And that is without any additional saving!
2) Start Early. You want to double your money as many times as you can, but let’s face it, a life expectancy of 85 years can only contains so many periods of 9 or 12 years. To maximize your wealth, you have to start as early as possible.
Let’s consider two investors: Smart Sally and Late Larry. Sally starts investing $500 a month at age 22, while Larry waits until he is 32. He’s still young, right? He also invests $500 a month and they both earn an 8% return until retirement at age 62. At age 62, here’s where they stand:
Smart Sally has $1,745,503. Late Larry has $745,179. Sally has a million dollars more because she started 10 years earlier! Not saving in your 20’s could mean you have a million dollars less for retirement. Don’t miss out on getting that extra doubling period.
3) Invest for Doubling. I see people with money markets in their retirement accounts even though they aren’t going to retire for decades. Nobody knows what the market is going to do tomorrow or this year, but if you are investing for 20 years, recognize that a 2% return will take 36 years to double and a 1% return will take 72 years. What does your money market pay in 2017? Less than 1%? At that rate, even your great-grandchildren won’t live long enough to see that double.
Stop thinking that a lack of volatility equals safety. Investing at a low rate of return basically guarantees that your money isn’t going to grow significantly. In that regards, cash is a riskier investment to your goals than stocks.
Use the rule of 72 to choose diversified investments that are in line with your goal of doubling your money. If you have the time and risk tolerance, you need to be invested in a way that will generate long-term returns of 6%, 8%, or more. The S&P 500 Index returned 12% annually from 1926 to 2010. Although our expected returns are lower today for stocks, they are also lower for cash, bonds, and inflation.
Let’s say that you are 41 and plan to retire at age 65, in 24 years. You have $250,000 today. if you are investing in a high quality bond fund that returns 3%, you will double your money once in 24 years, to $500,000. Invest in a balanced allocation at 6% expected return, and you will double every 12 years, bringing you to $1,000,000. But if you can invest aggressively, and achieve a 9% return, you could doubles your money three times, once every 8 years. That would bring you to $2 million at age 65.
If you understand the Rule of 72, you can focus on long-term results, starting early, and investing for growth. There will be volatility along the way; there will be down years and bear markets. But if you are in the accumulation phase of your life, your focus should be to strive for long-term returns that will double your money. And with retirement often lasting 20 to 30 years, age 65 is not the end, or a finish line, but just the start of a new phase of investing. You still need growth even in retirement!