How Does Rule of 72 Work? Let’s Talk About This Handy Mental Trick
Curious about a quick way to know How often do investments double? use the rule of 72 compound interest formula to answer
"There is no force in the universe more powerful than compound interest."
– Albert Einstein
Teaching the kiddos about investing as one of the three ways to consistently earn money is vital to giving them a strong money mindset, and the rule of 72 compound interest formula we believe is where a good conversation around investing can start.
Most people will learn about the rule of 72 concept in secondary school at some point, but we are betting that you have forgotten it (we have). This post is meant to serve as a reminder as well as give you some good ways to apply it to your real life today.
In this quick 3 minute read, we'll discuss:
What is the rule of 72?
How you can also relate the rule of 72 with inflation
The big secret behind why the rule of 72 works
Ways you can talk to the kids about the rule of 72 and compound interest
So let’s get started!
What Is The Rule Of 72?
The Rule of 72 is a simple formula that helps you calculate how long it will take your investment to double in value based on the rate of return it is earning you. The reverse is also true, and you can use it to calculate what rate of return you will need to have your investment double in a certain period of time.
To demonstrate, lets go through a couple examples together.
Let’s say that I put my money in the stock market this year and think that conservatively it can earn me about 5% a year as long as I keep it in there (The average return is ~10% over the last century but let’s be conservative as that number varies widely by time period). To find out how long it will take my money to double, I take the number 72 and divide it by 5 (my estimated return). The answer is almost 14 and a half years (72 / 5 = 14.4).
Now instead let’s say I want to figure out what return I will need for my investment to double in 10 years (instead of the ~14 above). Here we can also use the rule of 72 by dividing 72 by 10 (years I want my investment to double by) and coming out with 7.2. This means I will need a 7.2% return each year to have my investment double in 10 years.
Both ways can be a handy rule of thumb when you are thinking about how your investments will do (or want a quick mental trick to teach the kiddos).
Rule Of 72 And Inflation
The rule of 72 also can be used as a handy way to help you calculate the effect of inflation on your money today (we have written a lot about inflation lately on our School of Thought page).
Let’s go through an example. If inflation is 5% annually that means that money under your mattress is losing 5% of its value each year (costs are going up 5% you can’t buy the same amount of stuff with the same amount of money). If you keep your money stuffed under that mattress and inflation continues on at 5% each year, using the rule of 72 you can figure out how long it will take your money to lose half its value.
Taking 72 divided by 5 (the amount you are losing each year to inflation) means that in almost 14 and half years your money will lose half its value (72 / 5 = 14.4).
To think more about inflation and how increasing costs may affect your family check out our handy inflation calculator.
Power Of Compound Interest
The reason that the rule of 72 is so powerful is due to compound interest. This is what every serious investor utilizes to his or her advantage. If you make good investments and you have time on your side compound interest works like a snowball rolling down a hill.
At first, the snowball doesn’t do much as it starts to roll down from the top and you can stop it easily. But as it rolls it builds and builds steam getting bigger an bigger. As it keeps rolling and picking up steak it can turn into an avalanche the more it rolls.
The way the math works in this snowball analogy is that each year (or time period of your choosing) you are gaining a return on a larger and larger amount. For example, if you invest $1,000 and make a 10% return the first year, now in year two you have $1,100 (making $100).
Now when you go through year two and make 10% again, you are making $110 instead of $100 (10% of $1,100 is $110). As a result, when your money “snowball” is left alone and invested wisely this return gets bigger and bigger each year!
Rule of 72 Compound Interest Practice With The Kids
Now that we have talked about what the rule of 72 is, we have some suggestions for going through it with the kids.
Most kids won’t fully start learning about compound interest until around 7th or 8th grade (about 12 to 13 years old) but this doesn’t mean that you can start to introduce the rule of 72 as a handy short form tool or go over your own investments with them.
The cool thing is that the rule of 72 works with any type of investments (not just our stock market example above) and sitting down and talking with them about it will help this concept sink it.
You can talk about your house using the rule of 72 (ex. if your house rises in value by 10% each year how long will it take the value to double?), or maybe even some of their favorite collectibles (how long will it take the value of your favorite baseball card to double if it increases in value by 7% each year?). It can be applied to anything and it a great trick to get them learning!
If you want a bit more formal practice with the kids, check out our free downloadable compound interest sheet here or test out the rule of 72 calculator online by clicking the “Rule of 72 calculator” below!
Final Thoughts…
The rule of 72 is a quick and easy way to get you thinking about how long it may take your investments or money to double. It has also helped us with curbing spending (thinking if I saved $1,000 and invested it at x then I could have y amount in 10 years vs. buying this item now).
Regardless of how you use it, mental tricks like this can come in handy and we hope you found the post helpful.
