Rule of 72: Meaning, Formula, Benefits & How to Use?

What is the Rule of 72?

In finance, the Rule of 72 is a quick formula that can be used to estimate the time required to double the invested amount of money at a fixed annual rate of return.

While you can also use calculators and spreadsheet programs like excel sheets to calculate the time required to double the invested money accurately, the Rule of 72 is a good alternative for mental calculations that can give an approximate value quickly.

Formula and Example for Rule of 72

The Formula for Rule of 72 is – Years to Double = 72/Interest Rate

Where the interest rate is the fixed Rate of Return on an investment

For example,

If an investor invests Rs. 10000 and the annual interest rate is 4%

The time taken to double the investment = 72/4 = 18 years.

The Rule of 72 is a simple way of estimating the years required to double an investment’s value using a logarithmic formula.
It can be applied to growing values like investments, inflation, and GDP. The population can also be calculated using Rule 72
It is useful for understanding the effect of compound interest on your investments.

The Annual Percentage Yield for standard savings account in most banks is about 0.06 percent. At this rate, it would take about 800 years to double your investment.

How can you reduce the period required to double your investment?

1. You can keep a part of your savings in a high-yield savings account which offers a rate of interest of about 2.5 percent.

2. You can invest your money in stocks; some provide good returns with low risks. You can see your portfolio get more significant returns with stocks. The average return for S&P is about 7 percent.

Advantages of Rule of 72

1.Simplicity and Speed: Allows quick mental calculations to estimate the doubling time of an investment without complex math or tools.

2.Versatility: Applicable to a variety of financial scenarios including investments, inflation, GDP growth, and population estimates.

3.Educational Tool: Helps beginners understand the impact of compound interest and the importance of higher interest rates.

4.Decision Support: Aids investors in comparing the potential growth of different investments and choosing the best option for quicker gains.

5.Broad Application: Useful in personal finance for assessing savings growth and in debt management to understand how quickly debt can increase.

Disadvantages of Rule of 72

1. Rule 72 is mostly accurate for low-interest rates in the range of 6 percent to 10 percent, for interest rates outside this range, the Rule has to be adjusted by subtracting 1 from 72 for every 3-point divergence.

2. It can only give an estimate for a fixed return; it is not accurate when it comes to volatile investments.

Rule of 72 can also be used to calculate interest rates on a credit card, car loan, home loans, or student loan. It can show how many years it will take for the lender to double the amount. For beginners, these calculations can be quite complex. Rule 72 is a shortcut to calculate the time required for the investment to double itself.

Difference between Rule of 72 and Rule of 70

The Rule of 72 and the Rule of 70 are both quick formulas used to estimate the time required for an investment to double in value, but they differ slightly in their precision and application. The Rule of 72 is generally more accurate for interest rates between 6% and 10%, while the Rule of 70 is often used for lower interest rates and provides slightly faster estimates for doubling times. The Rule of 72 adjusts by subtracting 1 for every 3-point divergence from the range, whereas the Rule of 70 is better suited for continuous compounding or when a quicker, rougher estimate is acceptable. Both rules simplify complex calculations, but the choice between them depends on the specific rates and the desired accuracy.