The Rule of 72 is a simple formula that provides a good approximation of annual compounding. It allows an investor to estimate two things:
- The number of years it will take for your money to double at a given interest rate, or
- What interest rate should a person invest in if you wish to double your money in a given number of years.
The formula is to divide 72 by the interest rate (in %) and you get the number of years it will take to double you initial investment. (72/rate = years) For example, if you put P50000 in an investment instrument that’s estimated to give you an annual interest rate of 8%, to find out how many years it will take for your money to become P100000, simply divide 72 by 8 and that will give you 9 years. It will take approximately 9 years for your money to double if you invest it at an 8% interest rate if you allow it to compound annually.
Conversely, if you put P50000 in an investment instrument and you want to find out what interest rate would double your investment in 5 years, then you simply divide 72 by 5 and you get an answer of 14.4%.
This rule is most accurate at interest rates in the range of 6% -10%. For lower interest rates, you may want to use 70 instead of 72.
You can also use this rule to find out how many years it will take before inflation erodes the value of your money in half. Let’s say for example you keep your savings in a safety deposit box at home. Our country’s inflation rate as of January 2008 is 4.9%. If you divide 70 (because it’s more accurate than 72 at lower interest rates) by 4.9 you’ll get 14 years. That means if you’ve been keeping your P50000 savings in a safety deposit box at home, in 14 years, it’s value would be equivalent to just P25000.
This is one of the reasons why you would want to invest your money is something that gives a higher interest rate than the prevailing inflation rate.
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