What Is the Rule of 72, and How is it Used?

Feb 24

The Rule of 72 is a powerful yet simple financial concept that's served as a staple in the toolkit of investors, savers, and financial planners for decades. Offering a quick and easy way to estimate the timeframe needed for money to double at a given interest rate, this rule can help you make informed decisions about saving, investing, and planning for the future. In this article, we’ll delve into the Rule of 72 including what it is, how it’s used, and its various limitations.

What is the Rule of 72?

This well-known financial principle provides a quick and straightforward way to estimate the amount of time it takes an investment to double in value based on a fixed annual rate of return: a handy tool for novice and experienced investors alike who want to gauge the growth potential of investments in the absence of complex calculations.

Its basic premise is simple: divide 72 by the annual rate of return (expressed as a percentage) to determine the approximate number of years it will take for your investment to double.

How is the Rule of 72 calculated?

Let’s consider a specific example for calculation purposes, perhaps an investment that grew at an annual rate of 8%. In this case, you'd divide 72 by 8 and get 9: meaning it would take approximately 9 years for your investment to double in value if it continues to grow at an 8% annual rate.

Conversely, you can "rearrange" the rule if you want to know the rate of return necessary to double your money in a specific number of years: dividing 72 by the desired number of years to find the necessary annual return. If you want to double your money in 10 years, for example, you'd need an annual return of about 7.2% (72 ÷ 10 = 7.2).

The Rule of 72 is based on the mathematical concept of compound interest, wherein the value of an investment grows exponentially over time as interest is earned on both the initial principal and accumulated interest. Keep in mind, however, that this rule is an approximation and assumes a constant rate of return that may not reflect real-world investment performance fluctuations due to market volatility, economic changes, or other factors. The rule also doesn't account for fees, taxes, or inflation—all of which can affect the actual growth rate of an investment.

When is the Rule of 72 most useful?

Various financial scenarios, including many that go beyond simple investment earnings, call for the Rule of 72 such as…

Investment planning

Investors can use the Rule of 72 to set realistic expectations with respect to how long it will take to achieve their financial goals. For example, those planning for retirement can utilize it to estimate how long their savings would need to grow at a specific rate to reach the desired retirement fund size.

Interest rates and loans

The Rule of 72 is also applicable to debt. If you know the interest rate on a loan or credit card, for example, you can use the rule to understand how quickly your debt could double if you don't make any payments. Take those with a credit card interest rate of 18%, whose debt may in fact double in about 4 years (72 ÷ 18 = 4) according to the rule.

Inflation impacts

Finally, you can use the Rule of 72 to estimate the effects of inflation on purchasing power and thus plan for the future by considering related long-term savings impacts. With inflation of 3% per year, for example, you can expect the cost of goods and services to double in approximately 24 years (72 ÷ 3 = 24).

How to use the Rule of 72

While the Rule of 72 should only be used as part of a loose estimate, it can be helpful nonetheless. Take these examples where it's apt to provide some guidance…

Investment decisions

Emily is trying to decide between two investment options—a conservative bond fund that offers an average annual return of 4% and a more aggressive stock fund with an expected return of 8%—and wants to know how long it will take for her investment to double in each case.

Using the Rule of 72, Emily calculates the doubling time for the bond fund by dividing 72 by 4: giving her 18 years. For the stock fund, meanwhile, the rule's calculation spits out 9 years. While her investment in the bond fund would take about 18 years to double, the more aggressive stock fund would see doubling in half that time. Emily can use this information to weigh the trade-offs of risk and return, helping her decide which investment aligns better with her financial goals and time horizon.

Credit card debt

Alex's credit card has an outstanding balance of $10,000 and an annual interest rate of 15%. Only making minimum payments, he's concerned about how quickly his debt could grow if he doesn’t pay it off more aggressively.

Using the Rule of 72, Alex can estimate how long it will take for his credit card debt to double: dividing 72 by the interest rate (15%) to come up with 4.8 years. This means that if Alex doesn't make any payments, his $10,000 debt could balloon to $20,000 in less than five years—motivating him to pay more than the minimum to avoid this.

Retirement savings inflation impacts

David, with $200,000 saved for retirement and expecting to retire in 20 years, is concerned about how inflation might erode the value of his savings. Assuming an average inflation rate of 3%, he can use the Rule of 72 to estimate how much his savings will be worth in today’s dollars when he retires.

Dividing 72 by 3%, David learns his savings will lose half their purchasing power in 24 years (72 ÷ 3 = 24). This means that four years into his retirement, his $200,000 could be worth closer to $100,000 with respect to purchasing power and thus underscoring the need to invest his savings in a way that can outpace inflation: ensuring he has enough to maintain his desired lifestyle in retirement.

Rule of 72 limitations

While the Rule of 72 is a useful tool for quick calculations, it does have several notable limitations such as…

1. Approximation, not precision
With the rule providing a rough estimate rather than an exact answer, it is most accurate for an interest rate of 8% and its precision diminishes as the rate deviates significantly from this range. Any percentage between 4% and 15% should provide a decent approximation using the rule, but at very low (close to 1% or 2%) or very high (above 20%) interest rates, estimates may differ noticeably from a true calculation.

2. Assumes a constant interest rate
While the Rule of 72 accepts the interest rate will remain constant over the entire period assessed, in reality rates fluctuate due to economic conditions, monetary policy changes, or financial product adjustments. Even if the average annual return stays the same, the actual doubling period may be shorter or longer than the rule suggests given rate variations over time. The rule is therefore more accurate when used with fixed rate investments as opposed to those whose returns vary (e.g., stocks).

3. Ignores compounding frequency
The Rule of 72 assumes interest is compounded annually, but in many real-world scenarios, it's compounded more frequently—affecting estimate accuracy.

4. Limitation to exponential growth
The Rule of 72 is only applicable to situations involving exponential growth, wherein the growth rate is proportional to the current value, and thus doesn’t work well for non-exponential growth situations (e.g., linear growth models or scenarios involving irregular growth patterns).

5. Ignores additional contributions/withdrawals
The rule assumes the initial investment (or loan) remains untouched during the entire period, not accounting for additional contributions with respect to investments or minimum payments in the case of debt.

6. Ignores external factors
The Rule of 72 doesn’t take into account external factors that can affect investment growth such as taxes, fees, or inflation. Inflation—for example—can erode the real value of investment returns so that even if an investment doubles in nominal terms, its purchasing power may not have done the same. Likewise, fees and taxes can reduce the effective return and thus prolong the time needed for the investment to double.

7. Limited utility for complex financial products
While the Rule of 72 is convenient for basic interest-bearing accounts and simple investments, it may not be so useful for more complex financial products (e.g., variable annuities, hedge funds, or real estate investments) whereby returns are sometimes irregular and impacted by various factors beyond just interest rates.

The takeaway: the Rule of 72

While this rule is a valuable tool for quick mental calculations and setting expectations, its limitations mean it should be used with caution and not relied upon for precise financial planning. More accurate projections—especially with respect to varying interest rates, different compounding frequencies, or additional financial complexities—call for more detailed calculations or financial models. Knowing these limitations ensures investors and savers will use the Rule of 72 appropriately, supplementing it with other tools and financial advice as needed.

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