One reason why many people lack the patience and discipline required to reap the benefits of long-term investment is that they don’t begin with the end in mind.
Oftentimes, we neglect the long-term way of thinking that should guide our investment decisions and instead, are ready to abandon whatever progress we have made at the slightest hint of a market drawdown or economic recession.
Sometimes, we surrender to the pressures of life and use money that we invested for other purposes to solve some current, pressing needs.
This is why many people have not achieved financial independence and are living paycheck to paycheck.
One way we can have a clear picture of our investment goals is by using the Rule of 72. It brings clarity to your investment target by giving you the relative timeline it would take to attain them.
Let’s take a look at the Rule of 72 – and see how it can help when it comes to long term financial planning.
What is the Rule of 72?
The Rule of 72 is a ‘back of the envelope’ calculation used to estimate how long it will take an investment to double in value given a fixed annual rate of interest.
The calculation is simple – divide 72 by the annual rate of return to get a rough estimate of how many years it will take for your investment to double itself.
The Rule 72 formula is: 72 / interest rate = years to double
For example, if you invest in an asset that returns:
- 1%, it will take 72 years for your money to double (72 / 1 = 72)
- 2%, it will take 36 years for your money to double (72 / 2 = 36)
- 3%, it will take 24 years for your money to double (72 / 3 = 24)
- 5%, it will take 14.4 years years for your money to double (72 / 5 = 14.4)
- 10%, it will take 7.2 years for your money to double (72 / 10 = 7.2)
Top 4 Benefits of Using the Rule of 72
1. It puts financial goals in perspective.
The most obvious advantage of the Rule of 72 is that it puts a timeline to the realization of your financial goals.
It is much easier to stick to a goal or plan when we know what the outcome will look like.
Also, having a target allows us to measure and evaluate our progress and make the necessary adjustments needed to achieve our goals.
2. You know how long it takes to clear your debt.
The Rule of 72 allows you to know how long it could take to clear out your debt.
The tool is useful when calculating the duration of fixed interest loans such as mortgages, car loans, student loans, auto loans, or home equity lines of credit.
However, loans that have variable interest rates like credit cards can’t be calculated using the Rule of 72 because the percentage of interest fluctuates.
6 Ways Rising Interest Rates Can Impact Your Investments→
3. You know which investment will bring the highest returns.
The Rule of 72 makes you ask shrewd questions before making important money decisions.
If you understand and apply it to your investment analysis, you will be in a better position to know which investment would generate the highest returns within the shortest possible time.
You’ll recognize investments that don’t optimize the returns of your capital. This makes you less likely to fall for gimmicky financial products from banks and investment firms.
4. You recognize the power of investing over saving.
The Rule of 72 is a practical eye-opener that forces you to recognize the power of investing over savings.
Most people want to play safe, and just save their money.
Though saving is the first step in attaining financial independence, it lacks the firepower to give your finances the momentum it needs.
With inflation eroding the value of money, one can hardly dispute the immense benefits that come with investing.
Better still, when the returns from your investments are compounded over time using the Rule of 72, it’s a no-brainer on the place to put your money to work.
Is the Rule of 72 Accurate?
The Investing Rule of 72 isn’t exactly foolproof, as financial analysts have noted slight inaccuracies when using this tool.
The Rule of 72 is accurate for a range of interest rates (from 6% to 10%). Outside that range, the error will vary from 2.4% to 14.0%.
For example, it would take you 35 years to double an investment with a fixed interest rate of 2%. Using the Rule of 72, the time calculated amounts to takes 36 years.
Similarly, with a fixed interest rate of 25%, it takes 2.9 years to double your investment using the rule of 72. However, the actual time is 3.11 years to double your investment.
Our advice is to use it as a general guideline – you can do a deeper analysis once you decide what you’re committing to.
Despite the slight inaccuracies with the calculation, the main purpose of the Rule of 72 should not be discarded, which is to give you a timeline for your investment goals over the next two decades.
This is the tool’s most important attribute because it brings to the fore how an investment decision today will turn out to be decades from now.
So, using it as an incentive towards investing can be enough to propel you to achieve your financial goals. Good luck!
