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bar graph of time vs wealth below title Compounding and The Rule of 72

By Bob Barber, CWS®

Proverbs 21:5 “The plans of the diligent lead to profit as surely as haste leads to poverty.”

The Rule of 72 is a mathematical formula I think everyone needs to know and understand when it comes to investing. This rule is extremely powerful and can be used to determine how often a lump sum will double or compound. It’s important to know how the Rule of 72 works because it can mean the difference in having tens of thousands, or even hundred of thousands, of dollars over a lifetime of investing and saving, as well as what it can cost you when taking premature withdrawals from an investment portfolio.

The formula works like this: 72 divided by an annual “average rate of return” of an investment equals the “amount of years” the lump sum invested will double.

Examples:

1) A $10,000 investment making an average annual rate of return of 2% would double to $20,000 in 36 years:
72 / 2 (percent) = 36 (years)

2) A $10,000 investment making an average annual rate of return of 6% would double to $20,000 in 12 years:
72 / 6 (percent) = 12 (years)

$40,000 in 24 years and $80,000 in 36 years

3) A $10,000 investment making an average annual rate of return of 8% would double to $20,000 in 9 years:
72 / 8 (percent) = 9 (years)

$40,000 in 18 years, $80,000 in 27 years, and $160,000 in 36 years

You get the picture. The better the annual average rate of return you can make, the faster an investment can compound and double, and those extra doubles really mean a lot over an extended period of time.

You can use the Rule of 72 in so many different scenarios, like how much a lump sum could grow to at a certain average rate of return over many years or what it could monetarily cost you in lost returns by withdrawing money from an investment growing at an average stated rate of return to buy a depreciating asset.

Example: Let’s say you withdraw $30,000 from an investment portfolio to buy a new car. If the $30,000 you withdrew was averaging a rate of return of 6%, over the next 12 years that would lower what would have been in your investment portfolio by $60,000 or in 24 years $120,000. What would the car be worth in 24 years? I bet not anywhere worth that.

Personally, understanding how the Rule of 72 works and applying it to just about every financial decision I have made over the last 30 years has not just meant tens of thousands of dollars but tens of hundreds of thousands of dollars to my net worth. I learned the Rule of 72 when I was very young, and I still remember to this day the “light” going off in my head of what it could mean to my future if I applied it. I’m so thankful that I did and that someone taught me the Rule of 72 years ago.

My hope is that you will apply this rule to your own financial decisions as well, stay disciplined, and stick to the plan because it’s worth it.

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