How Understanding the ‘Rule of 72’ Helps You Make Personal Finance Decisions
Though everybody wants their money to grow, few people understand the best way to make that happen. It’s all about where you choose to put your money and the rate of growth you’re able to achieve over a period of time. When figuring out how compound interest works, the “rule of 72” is one of the most helpful tools.
What is the Rule of 72?
The Rule of 72 is a helpful, easy-to-understand formula that predicts how many years it takes money to double based on a specific rate of return. You can use it to make decisions about where to put your money based on how much time you have for it to grow and what your risk tolerance is. If your goal is to have twice as much when you finish as when you start, you can identify the interest rate you need based on how much time you have. All you need is the interest rate to complete the calculation, which is based on the following formula:
72 / interest rate = years to double
With this simple calculation, you can look at the interest rate offered by various savings tools or anticipated growth of investments and see exactly how long it will take for your money to double. Here’s how different rates of interest impact the time needed to double:
At 1%, it will take 72 years for your money to double (72 / 1 = 72)
At 3%, it will take 24 years for your money to double (72 / 3 = 24)
At 6%, it will take 12 years for your money to double (72 / 6 = 12)
At 9%, it will take 8 years for your money to double (72 / 9 = 8)
At 12%, it will take 6 years for your money to double (72 / 12 = 6)
This list provides as clear a picture as anybody could possibly need of the difference between parking your money in a super-safe, standard savings account that pays 0.09% and investing in a riskier investment such as the stock market, where the average annualized total return for the S&P 500 index has been just shy of 10% over the last 90 years. It’s a 790-year difference when it comes to doubling!
The same formula can be very useful when taking out loans. Whether you are looking for a new car, a mortgage for a home purchase, or paying interest on your credit card, if you divide 72 by your interest rate, you’ll see exactly how fast the lender (or credit card company) is doubling the money that you’re paying them. It’s a helpful guide to steering clear usury rates by loan shopping and understanding the advantages of refinancing.
As straightforward as the Rule of 72 is, getting your personal finances in order can be a complicated task. For help navigating complex decisions, contact our office today to set up a time to discuss your specific needs and goals.