The Rule of 72, Using My Rule of 70, and The Power of Time (Compounding)

One of the financial principles I use regularly is the Rule of 72 (I actually use the rule of 70, but more on that later.) Here's an example of how it works from the book The Net Worth Workout: A Powerful Program for a Lifetime of Financial Fitness (see my rating for details):

According to the Rule of 72, if you want to fine the number of years it will take to double your money at a certain investment rate you divide the investment rate into seventy-two.

So, for instance, if you have an investment that earns 10% a year, it will take 7.2 years to double (72 divided by 10.)

As I said, I use the "Rule of 70" myself. I use this to estimate how my investments will do through the years. Since I use 10% as a rough rate of return when I think of how my investments will perform over the next couple decades and since 70 easily divides into an even 7 years (versus 7.2 years for the Rule of 72), I just use it to get a general feeling of where I'll be in 7, 14, and 21 years. Here's an example:

• Let's say I have $50,000 invested today.

• I expect it to earn roughly 10%, so it would double in seven years using my rule (or you can call it a guideline if you prefer) of 70.

• That means in seven years, it will be worth $100,000.

• In 14 years, it will be worth $200,000 (it will have doubled again from the $100,000 level.)

• In 21 years, it will be worth $400,000.

Of course, this assumes that I don't make any additional contributions to my investments. If I did, it would be worth more than this. Also, it assumes that I don't withdraw any money from the investment -- otherwise, it would be below $400,000.

For those of you who are young enough to have several seven-year periods before you need the money, you can see how a relatively small amount compounds and can turn into a big nest egg. Let's assume you're 22 years old, have $25,000 saved, and can earn 10% on it. Here's how you'd do (roughly) using my rule of 70:

• At 29, you'd have $50,000
• At 36, you'd have $100,000
• At 43, you'd have $200,000
• At 50, you'd have $400,000
• At 57, you'd have $800,000
• At 64, you'd have $1,600,000

See how time can really work for you? It's a beautiful thing. ;-)

Comments

[Kurt]

Two caveats: no taxes, and at 10%, it's actually closer to 9 years than it is to 7 (a shade over 8).

[Kurt]

And while I realize this is a rule of thumb, at 64 years old, in your example, your rule of thumb is off by 14.4% or over $200,000.

Compounding is great when it's interest you're talking about, not so much when it's errors.

[MrAtoZ]

Unfortunately many seasoned investing pros - like Buffett and Bogle - think that overall equity returns will be closer to 7% than 10% in the coming decades, as market performances revert to historical averages. That means you may have to count in decade-long increments, not just 7 year periods, to double your money. Not a big deal if you're 25; 50 is a different matter.

MrAtoZ has a great point. And there's also the fact that market returns aren't an actuarial table. Even if real returns do average in at 10%, the order of returns make a big difference. Actual returns could be much lower.

[FMF]

Good points by all of you -- that's why I use it only as a general guide (when I'm away from a calculator or spreadsheet.) In addition, I use it mostly when thinking about my net worth -- which has averaged 16% per year gains the past 15 or so years, so I have a lot of wiggle room in my estimates.

[InaDaze]

Compound interest as it relates to personal finance/retirement should be taught in every high school in the nation, thats more important if you ask me than half of the stuff you would learn in an english or history course

[maxthrottle]

Of course this completely fails to take into account taxes and trading costs. As you make more you will be taxed at a higher rate. If the account is interest bearing it's all taxable, if a stock you'll be taxed on the dividends and then when you sell, on the gains. With tax rates up to 35% this would require you to earn more than 10% for this to remain true. IF you earn 10%, (which is highly optimistic) but lose 30% to taxes, although if you hold the asset long enough the capital gins tax on the sale will only be 15%. Anyway dividing that 7 (whats left over after your are taxed on your interest)into your 72 means you'll take 10.2 years to double your money. Sometimes reality hurts..

[Ty]

this also fails to mention the real value of the money saved. If you earn 10% and inflation is 4%, then in real terms (i.e. the amount of stuff that you can get with all this money you save) the money only grows at 6%...