How many of you wonder how financial professionals can so quickly mentally calculate how much money you’ll have in 30 years based on an return on the investment? Well, the magic can be easily attributed to the Rule of 72.
In order to use the Rule of 72, all you need to know is how to divide various numbers into 72. For example, 9 divides into 72 8 times. 10 divides into 72 7.2 times. Etc.
Once you have become the master in the basic division tables for 72, you can start to apply this k to calculations like investment returns. Divide the annual rate of return (percentage) into 72, and the answer will be the number of years it will take to double your money.
For example, if you assume your investment is earning 8%/year every year (and 8 divides into 72 9 times), then your money will double every 9 years. If you are earning 4%/year, your money will double every 18 years (72 divided by 4 equals 18).
This is an easy technique to quickly estimate what your net worth will be down the road given a certain rate of return. It may even help you decide what sort of investments to choose, based on their risk to reward ratios.
If you have Rs. 10,000 invested at 3%/year for example, it will become Rs. 20,000 in 24 years (72 divided by 3 equals 24), and Rs. 40,000 in 48 years (24 times 2).
If instead you invest the same Rs. 10,000 at 6%, it will become Rs. 20,000 in 12 years, Rs.40,000 in 24 years, and Rs. 80,000 in 48 years. A small change in percentage can make a huge difference.
The downside of this calculation method, is that rarely do investments give the same return year after year. You can achieve an average annual rate of return of “x”%, but in the end the total calculations won’t entirely work out with your Rule of 72 plan.
So all in all it’s not a very accurate method of planning your finances, but a useful tip for on-the-fly calculations, and maybe even a party trick.
