The rule of 72 is an approximation tool used to determine the amount of time it will take for money to double on the earnings of compound interest.
Rule of 72 Explained
The rule of 72 is essentially an estimation for determining the amount of years or the doubling time of an investment. Do this by taking the interest available on the investment. Then divide it by 72. This type of investing is usually fairly accurate, it is more accurate with lower interest rates than it is for higher ones. It is normally used solely for compound interest situations and is not a very good indicator if the investment earns a simple interest at the end of the investment term. This rule is most useful if an investor cannot perform an exponential function and simply needs to do simple math for an estimate of an investment.
Rule of 72 Formula
Use the following rule of 72 formula:
Doubling Time (# years) = 72/Interest Rate
Example
What is the doubling time for an investment with a compound interest rate of 8%? A person using the rule of 72 equation would find the doubling time equal to 9 years. Calculate it by dividing 8 by 72. By performing this, the investor can tell that it will take approximately 9 years to double the principal. It is fairly accurate as the exponential function yields an actual doubling time of 9.006 years.
See Also:
Investment Banks
NPV vs Payback Method
Internal Rate of Return Method
Weighted Average Cost of Capital (WACC)
Effective Rate of Interest Calculation
