Estimating Growth and Decay Using The Rule of 72
What is the rule?
If you’re interested in personal finance, the Rule of 72 is a helpful rule of thumb to estimate how long it will take to double your money at an annual rate.
The Rule of 72 is based on the idea that if you divide the number 72 into the annual interest rate, you will get the number of years it will take for your investment to double. For example, if you have an investment that earns 10% annually, it will take 7.2 years for your investment to double.
Using the rule
As illustrated by the table below, it doesn’t take much change in rate of return to drastically change how fast our investment will compound. The difference between a 6% and 9% growth rate is 4 years. This type of comparison can be useful not only when comparing different assets, but also when thinking about fees. An account or maintenance fee of just 1% can compound to be significant over time.
A 1% maintenance fee on an estimated 9% rate of return increases the doubling time by 1 year. Compounded over a lifetime, this could add up to a substantial amount of money. Far greater than the initial 1% might appear at first glance.
|Interest rate||Years to double|
Tracking decay and the impact of inflation
We can use the rule of 72 to not only track the growth of money, but also the decay of money. In other words, we can determine the impact of inflation. If we think of the rate of inflation as reducing the purchasing power of an investment, we can determine how long it will take that purchasing power to half. For instance, an inflation rate of 5% will half an investment’s purchasing power in 14.4 years.