The Rule Of 72
The Rule of 72 is just math, but it is an extremely useful rule of thumb for investing. The rule of 72 is a shortcut to estimate the number of years required to double your money. With the Rule of 72, you simply divide 72 by the percentage return you get on your investments and that’s the amount of time it takes to double your money. The rule is fairly accurate for interest rates between 6% & 10%. When dealing with rates outside this range, the rule can be adjusted by adding or subtracting 1 from 72 for every 3 points the interest rate diverges from 8%.
How long it takes
Annual Return-Years To Double
Investing in S&P 500 Index
Stocks are one of many possible ways to invest your money. While future performance is never guaranteed, history suggests the long term average of the S&P 500 Index is 10% per year from 1928-2016. So if you were 100% invested in the S&P 500 Index you would have doubled your money every 7.2 years.
If you are sitting in all cash or low-yielding GIC/CD averaging 1%, your money will double in 72 years. You can invest in government bonds that yield 2-3%, which moves your doubling time from 72 years to 25-30 years.
Going up the risk scale is alternative investing, which includes things like real estate, REITs, private equity, etc. These alternative investments can often yield much higher returns with different risks and rewards. If you are extremely fortunate and make a return of 20% per year, you would double your money in 3.6 years. (Not Bad!!)
The impact of inflation
Another thing to consider is inflation. Inflation and bear markets are retiree’s worst enemy. Inflation averages about 2%-3% a year. A 3% inflation rate would mean your money will lose half its spending power in 24 years. This is certainly useful to know when planning your retirement! That means if you are using the 10% per year average of the S&P 500 with 2% inflation you need a return of approximately 12% per year, so that your money has double the purchasing power in 7.2 years than it has now.
Death and taxes, if you are investing outside your tax advantage accounts you will have to figure in the taxes along with inflation. The Rule of 72 assumes a set rate of return, but the stock market doesn’t offer stable returns. One year you might see 15%, the next only 4%, and some years are negative for the stock market. In real life, your returns very, even though you have annualized returns over time that tend to even out. I never use a 10% return in any calculations I run, usually I use a figure of a 4% return and hope I am pleasantly surprised in 20 years. I only use the rule of 72 as a quick tool to guestimate my portfolio performance and to project future net worth scenarios. Check out the Word of the Week Rule of 72.