Sunday, February 13, 2011

The Rule of 72 in a different light

We previously discussed the the Rule of 72 as a simplified way to find out how long an investment will take to double at a given interest rate. Here’s how it goes:
Divide 72 by the given interest rate and you can find out how many years it will take double your money.
The Rule of 72 also works in another way;  you can find out the exact interest rate or rate of return needed if you wanted to double your money within a certain number of years. You can rework the Rule of 72 like this:

72 ÷ # of years = the rate needed to double your money

Here is an example:
Let’s say you saved up $5,000. Now you would like to double that amount in the next 6 years but you are not sure what type of investment or interest would be needed to achieve that goal. Let’s plug in the numbers...

      72 ÷ 6 (years) = 12 (%)

Solution: In order to double $5,000 in 6 years time, you will need to find an investment giving you a compounded annual return of 12%.

Really simple stuff, but you should consider using this as a gauge when looking at your own financial planning.  If your time horizon is say 10 years, remember that you need about 7% of compounded annual return to double your money.  This might come in handy when you talk to your broker the next time.