Lets see what does the amazing Rule of 72 indicates in investing money.
The rule of 72 is one of the easiest to remember rules of investing.
This rule does not tell you which stocks to buy, but will surely help you to discover a different aspect of investing money.
I will give you some exemplification of this simple rule of 72 to make you aware of its powers.
#1. What does 8% interest means to you?
You can use the rule of 72 to answer this question.
If you will ask a layman probably he will only falter on this question.
How in a world anybody can make a meaning of a percentage value?
Yes you can do it if you know the rule of 72.
Divide the magic number 72 with 8 and answer will be 9.
It means, it will take nine years to get the money doubled if an investment is offering 8% annualized returns.
|SL||Interest||Number of Years it takes the money to double|
#2. Rule of 72 – Double Money
What returns one must earn to double money in one year?
Here the number of years is equal to one.
In this case, the returns will be 72/1= 72% p.a.
Yes, this realization is important.
The realisation about how real are our expectation from our investment is highlighted from rule of 72.
We all think to double our money as fast as possible.
Some time we expect money to get double in months.
But see how difficult it is to double the money.
We get this understanding when we convert our expectation to a percentage value.
A knowledgeable person of stock market will tell you that.
Best returns from stock market can be in tune of 16-18% per annum.
That too is possible only when a person hold good stocks for very long period (5-7 years or more).
So a realistic expectation is 16-18% return from stock market.
But lets see what we generally expect from stock market.
Lets convert our expectation into hard numbers:
|SL||Expectation to double money in (time)||Interest that is required to make the expectation a reality (p.a.)|
From this table it is very evident that what expectations are realistic from stock market.
Stock market can double ones money between 4 to 5 years.
But how many of us are ready to hold a stock for this long?
The answer is not many.
The power of rule of 72 is this, it helps people decipher dreams from reality.
In investment world, more are day-dreamers and less are aware about the reality.
For day dreamers, rule of 72 is a great WAKE-UP tool
#3. Important realisations…
What can the rule of 72 tell us?
#3.1 – About Savings Account
How many years it will take my money to get double if I keep it in savings account?
My savings account offer me interest earning of 4% per annum.
By applying rule of 72, it will take 18 years for my money to get double.
#3.2 – About Index Fund
How many years it will take my money to get double if I invest it in index fund?
Index funds on an average gives 12% per annum returns.
In this case it will take 6 years for money to get doubled.
#3.3 – About Inflation
What it means to have inflation rate of 3%, 5%, 8% or 12% per annum?
Here again we can use the rule of 72 to give a perfect answer.
|3%||24 years||In 24 years the value of money will be halved due to inflation @ 3%|
|5%||14.4 years||In 14.4 years the value of money will be halved due to inflation @ 5%|
|8%||9 years||In 9 years the value of money will be halved due to inflation @ 8%|
|12%||6 years||In 6 years the value of money will be halved due to inflation @ 12%|
#3.4 – About Credit card
What is the difference between Credit Card Loan and Personal Loan?
Interest charged on credit card loan is 33% per annum.
It means if we do not pay loan for 2.19 years (72/33) the outstanding loan will double in value
Interest charged on personal loan is 16% per annum.
It means if we do not pay loan for 4 years (72/16) the outstanding loan will double in value.
I found the article interesting. However, on Rule#2, it is not clear to me when you say 72% return is needed to double the money in 1 year.
To me it looks like 100% to double it in a year. Appreciate if you could please help clear it.