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When we put our money in the market, or before we even do, one of the biggest questions we have is: How long will it take for this investment to really grow?
Luckily, there's a mathematical shortcut to help you estimate the future value of an investment. The Rule of 72 is a quick way to figure out approximately the number of years needed to double your invested money.
Using your rate of return, the Rule of 72 is a simplified formula that measures the effect of compound interest on your investment dollars. As a refresher, compound interest is calculated on your principal amount, plus your accumulated interest. It essentially pays interest on top of interest and is a huge perk of investing in the market since your interest earned is automatically reinvested, earning you even more.
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To use the Rule of 72 formula, simply divide 72 by the expected annual rate of return. Take note that the formula assumes the same rate over the life of the investment.
As an example, say you invest $50,000 in a mutual fund that has a hypothetical 6% average rate of return. By using the Rule of 72 formula, your calculation will look like this: 72/6 = 12. This tells you that, at a 6% annual rate of return, you can expect your investment to double in value — to be worth $100,000 — in roughly 12 years.
When calculating the Rule of 72 for any investment, note that the formula is an estimation tool and the years are approximate. The Rule of 72 mainly works with common rates of return that are in the range of 5% to 12%, with an 8% return as the benchmark of accuracy. Lower or higher rates outside of this range can be better predicted using an adjusted Rule of 71, 73 or 74, depending on how far they fall below or above the range. You generally add one to 72 for every three percentage point increase. So, a 15% rate of return would mean you use the Rule of 73.
Keep in mind that a mutual fund or index fund are smart investing options, especially for beginners, as it offers instant diversification by pooling money from many individuals to invest in a collection of companies. They also offer somewhat predictable returns over the long run. For instance, S&P 500 index funds have returned about an 11% average annualized return since 1950, be it with significant downward and upward swings in some years.
Robo-advisors like Wealthfront, Betterment and SoFi will build you a portfolio of index funds (usually in the form of ETFs) based on your risk tolerance, time horizon and investing goals. These are good platforms to use when you're just starting out investing since robo-advisors automatically rebalance your portfolio for you and as you get closer to your investing targets. If you want more control over your investments consider a brokerage that doesn't charge commission fees, like Charles Schwab or Fidelity.
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The Rule of 72 can also help you see how long it would take for the effect of inflation to cut your money in half.
As an example, say you have $100,000 and expect a hypothetical long-term inflation rate of 3%. Since inflation reduces your purchasing power over time, your $100,000, if not invested, would lose half its value (aka be worth $50,000) by 24 years. The calculation for this looks like: 72/3 = 24. If inflation increases from a rate of 3% to 6%, that same $100,000 would lose half its value even faster — in just 12 years (72/6 = 12).
The Rule of 72 is an easy way to quickly find out when your investments will double in value. It can also help you see how soon or far out inflation would eventually cut your money's value in half.