Recently, a friend and I were discussing interest rates and how long it would take to double your money. During our discussion he introduced me to the Rule of 72. It is a simple and fairly accurate formula to determine the number of years it takes to double your money at different interest rates. You simply divide 72 by the average annual return percentage on your savings or investments to get the approximate number of years it takes to double your money.
An 8% return doubles your money in nine (9) years:
72 divided by 8 = 9
A 10% return doubles your money in 7.2 years:
72 divided by 10 = 7.2
It should be noted that the Rule of 72 applies to exponential growth and is therefore usedfor ‘compound interest’ as opposed to simple interest calculations. Compound interest is defined as the interest that accrues on the initial principal and the accumulated interest of a deposit, loan or debt. Compounding of interest allows the principal amount to grow at a faster rate than simple interest; which is calculated as a percentage of the principal amount only. (Investopedia.com) In short compound interest happens when interest is added to the principal amount, so that from that moment on, the interest that has been addes also earns interest. For example, a $1,000.00 deposit that has grown to $1,150.00, via compound interest, would have interest figured on the $1,150.00 amount and not the original deposit amount of $1,000.00.
Next time you find yourself needing to do a quick calculation of how an investment might work out for you remember the Rule of 72.