One of the most common questions people ask in investing is “how can I double my money”?
While this question is well-intended, it fails to consider an important element - how long does it take to double your money? And here, faster isn’t necessarily better (see footnotes).
Allow us to introduce you to one of the most useful rules-of-thumb in personal finance - The Rule of 72 (cue dramatic music). It is your investing B.S. detector, and handy party trick (if people are impressed by your whizz math skills). Without further ado, here we go:
What is it? How does it work?
The Rule of 72 says that to get an estimate of the number of years it takes to double your money at a specific return/growth rate, simply divide 72 by the growth rate. For example, to estimate how long it’ll take for your investment that grows at 9% annually to double, take 72/9% = 8 years.
You can also apply it in reverse - divide 72 by the number of years. So in this case, to find the growth rate you need to double your money in 8 years, take 72/8years = 9%
Lastly, you can apply it repeatedly. For example, if money will double in 8 years (previous example), it will double AGAIN in another 8 years. So:
Year 8: 2,000
Year 16: 4,000
Pretty fantastic, especially if you have long-term goals you’re planning for!
Y = 72 / r and r = 72 / Y (where Y and r are the years and interest rate, respectively)
How can you use it?
In part because of how simple this rule-of-thumb is to apply, it’s incredibly useful. For example:
Sanity check things people are saying
Someone who wants your investment: “This investment will double your money in 3 years!”
You: Hmmm...that means it’s growing at 24% each year. Is that reasonable? Does that match up with what the market is saying?
Double-check numbers in investments
Someone who wants your investment: “We’re growing money at 10% per year, so your money (20,000) will be 40,000 in 4 years”
You: Hmmm...that’s impossible - at 10% per year it’ll be double in 7.2 years, so I think you’re lying
Someone who wants your investment but has been caught in a lie: Forgive me, oh wise one (bows and scurries away, in awe of your math genius)
Estimate your own future returns and compare to alternatives
You comparing investments: Hmm...what are my options with this lump-sum I have? My daughter is going to university in 16 years. If I take this investment that grows at 9% per year, it will double in 8 years. So my money can double twice! Perfect, that’s enough to pay for her first year!
Future you (in 16 years): Thank you, oh wise one.
Creation of superhuman strength (this use has no verifiable sources)
Someone who wants your help opening a jar: “Hey, could you help?”
You: I have just the thing! (remembers rule)
Rule of 72: Sorry buddy, you’re on your own here
Assumptions & limitations of the Rule of 72
Assumes that money compounds annually. Not as effective for investments that compound more/less than once a year. For example, 100 grown at 10% annually is 110 in Year 1, and 121 in Year 2 (for further examples on compounding, check out our compound interest calculator)
It’s highly effective for lower interest/growth/return rates, and is less accurate with extremely high numbers. The table below highlights this:
Why isn’t a higher potential return necessarily better?
Generally, the higher the potential return on an investment (how much you can “make”) from it, the higher the risk. However, there is no guarantee that because you accepted more risk you actually get a higher return. Things simply might not work out, the investment fails, and you lose your money. So don’t blindly chase higher returns. Instead, intentionally build your investments around the life you’re working towards creating