What is the Rule of 72 and How Can It Help You Double Your Money?
Read more about Compound Interest: Split Personality
Thirty years ago, the rule of 72 was one of the most popular concepts in personal finance, and financial advisors around the country used it to encourage people to save and invest toward the future. Baby boomers in particular were fond of using the rule of 72 to demonstrate the power of compounding interest and the importance of saving young and saving often.
What is the rule of 72? It's a simple calculation that approximates how long it will take for your money to double by dividing the number 72 by the rate of interest you will earn. For instance, if your investment earns 5%, the rule of 72 says that your money will double in 14.4 years, because 72/5 = 14.4.
The rule of 72 isn't completely accurate, and is used more as a guideline than anything else. In reality, an investment earning 5% will double after 14.21 years.
The rule of 72 is most accurate for interest rates between 7% and 9%, where the difference between how long it actually takes to double your money and how long the rule of 72 says it will take is a small fraction. For instance, the rule of 72 says it will take 8 years for your money to double at 9% interest, but it actually takes 8.04 years. In other words, it's wrong by about two weeks.
Nowadays, the rule of 72 is becoming a distant memory. A recent survey by CreditDonkey.com showed that 85.7% of people did not know what the rule of 72 is. The survey polled over 1,000 people on a number of questions about savings and personal finance; 86.4% of respondents were under the age of 45--almost identical to the number of respondents who were unfamiliar with the rule of 72.
While the proliferation of easy-to-use interest calculators on the web has made shortcuts like the rule of 72 unnecessary for anyone with a smartphone and fast fingers, Charles Tran of CreditDonkey.com thinks there's more going on. "The so-called rule of 72 was really popular in the 70s when savings accounts at local banks offered interest rates over 6% or 7%," said Tran. "While inflation was high in those days, yields on all types of investments were much higher than they are today. Long-term U.S. government bonds offered rates over 14% in the early 1980s, when a lot of our survey respondents were just being born," noted Tran.
In contrast to those days of heady yields, modern-day government bonds offer rates below 3%, and consumers are happy to find bank accounts that don't have high fees, let alone generous interest rates. "It's just hard to make a profit from investing these days, so the rule of 72 just isn't as important a guideline for people nowadays."
On very low yields, the rule of 72 is much more inaccurate. An investment yielding 2% doubles after 36 years, according to the rule of 72. In actuality, it takes 35 years--a difference of one full year.
More Articles in Money Tips
Compound interest – the wonderful banking principle that helps your savings grow at a faster rate each year. Simply set up automatic deduction from your paycheck, sit back, watch your retirement grow and let your worries fly away. If only it ...
What do you think about What is the Rule of 72 and How Can It Help You Double Your Money?
You might also be interested in
More Articles in Money Tips