What is Rule of 72 ?
Rule of 72 in finance is a formula that can help individuals to determine the time it will take for an investment to double in value at a given rate of return. It can also estimate the rate of interest for a certain instrument of investment if they know how many years it will take to double the amount invested. This formula makes a rough estimation and not a completely accurate one.
The Rule of 72 works best when the interest rate is 8%; the further away from 8% you go in either direction, the result is less accurate. Yet, using this helpful formula might give you a better idea of how much your money might increase over time, given a particular rate of return.
Formula for the Rule of 72 :
Using formulas mentioned below individuals can calculate the numbers of years or rate of interest needed to double the invested amount:
1. Formula to measure the number of years to double the invested amount :
Years = 72 / rate of Interest
Individuals who wants to start their investment journey have to divide 72 by the given interest rate to know how many years they will have to keep invested for doubling the money.
Let us assume for example that the annual interest rate of fixed deposit is 8%. By applying the formula we can deduce that the fund will be doubled after 9 years.
2. Formula to measure the interest rate to double the invested amount :
Interest Rate = 72 / ( Number of years to double a certain amount)
Individuals have to divide 72 by the time frame they want their fund to be doubled up. With rule of 72 , they can estimate the interest rate given on their instruments of investment without even taking help of compounding calculator.
Benefits of the Rule of 72 :
- Easy to utilize because it is a straightforward strategy
- Individuals can modify their positions and risk exposure as needed.
- It enables investors to calculate the time it will take for their money to double.
- Can be used to any market variable, including GDP, population rate, and so on, as long as an annual rate of interest is expected.
- It provides investors with a definite time period for when they can sell their investment holdings for a profit of two to one.
Drawbacks of the Rule of 72 :
- Investments with simple interest and those with variable interest rates do not comply with the Rule of 72.
- It is not a exact figure and can only provide an estimate of the time required to double an investment.
- For lower rates of returns, the Rule of 72 is often accurate. However, any more significant than that, the projected value may change.
- The Rule of 72 becomes null and void if the interest rate changes due to any factor.
Conclusion :
When deciding how much to invest, it is very important to remember the rule of 72. If an individual starts investing early, even a modest sum of amount may have a significant influence. Rule of 72 can be used for any calculation that involves compounded growth, for example this formula can be applied to mutual funds, fixed deposit values, GDP growth etc given that interest rates remains unchanged.
