The Rule of 72 in Finance Explained for Beginners

The Rule of 72 in finance is generally associated with a formula that is used to estimate how much time it will take for investment to double its value. The rule of 72 formula is used when earning a fixed rate of return per year. The easiest way to calculate the shortcut is to divide 72 by the interest rate you get annually.

In this article, we will show a real rule of 72 example as well as explain how the formula works and how to use it when calculating potential returns.

What Is the Rule of 72?

Once again, the formula makes it possible to calculate how many years you may need to double your investments in value when considering a given annual rate of return. Additionally, the calculation can serve as the instrument to estimate the rate of annual compounded return.

Of course, one can benefit from niche-specific software like Microsoft Excel, Google Sheets, and other spreadsheet apps. However, they work more for precise calculation while the rule of 72 is more like a mental tool to benefit from instant results when identifying the approximate value.

This is what makes the formula a great tool for beginner traders. It teaches them to both comprehend and calculate in real time without using side applications or tools. What’s more, the rule is used by financial institutions and organizations, for example, the Security and Exchange Commission for maintaining grade-level financial literacy channels.

The Story behind the Rule of 72

The rule originated in 1494. Luca Pacioli was the first one to introduce it in his mathematical work known as Summa de Arithmetica. The main issue here is that Pacioli does not provide any explanation of how he worked out the formula. Also, you will not find its explanation in his book. So, some people believe that the mathematician used the formula that pre-dates his work.

The Rule of 72 Calculation

The rule is very simple to use. All you need is to divide 72 by the annual return generated by your investments. In the end, you will know how many years it will take you to double your original income.

The Rule of 72 example: let’s say, you are planning to invest in a security that promises 8% of the annual return. The calculation goes like this: 72/8 = 9. It means you will need 9 years to double your investment.

The cool thing about the formula is the ability to leverage it differently. You can use two ways to estimate the period needed to double the required rate of return. Here are these two methods:

1. Time to Double – the first approach supposes determining doubling time. To calculate it, you need to divide 72 by the expected rate of return (as in example shown earlier). The main factor here is that the formula uses only a single average rate throughout the initial investment lifespan.
2. Expected Rate of Return – another approach is to calculate the expected rate of return rather than timeframes. Here you will need to divide 72 by the years to double the investment. The number of years should not necessarily be a whole number. You can easily complete the calculation using portions or fractions of the year. The good news is that the result you get will cover compounding interest rate over the whole investment holding period.

The Bottom Line

The Rule of 72 can be a simple and useful tool to quickly calculate potential time needed to double your investment as well as expected rate of return. The formula is very simple, which makes it a good option for beginners whenever they need to estimate the potential profit in the long run when deciding whether to select an asset or not.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.