The easiest definition for Rule of 72 is that it is used to measure how fast your money can grow. Lately, investors learned that the number 72 is actually a magical number which can be used as a quick way to determine how long it takes for an investment to double in value with a given yield. This rule will help you to estimate how many years it will take to double an investment by compounding.
How to Calculate?
The calculation for Rule of 72 is very easy and simple. The formula to calculate the number of years it will take to approximately double the original amount of money is:
How accurate is this rule?
In order to answer this, the table below will compare the amount of time required to double an investment by Rule of 72 and the actual number of years.
The table shows that the difference between the number of years calculated by Rule of 72 and actual number of years is very little.
Why Rule of 72?
Rule of 72 is a valuable tool in investment planning. Based on calculations, if an investment is earning 8% per year it will take approximately 9 years to double it. This means that a RM10,000 investment at age 20 would grow to RM20,000 at age 29 without any additional capital. This illustrates the power of exponential and compound growth as well as the importance of time. Does this make a difference to your everyday life? Probably not, but it is a crucial piece for your investment future. Albert Einstein once said: “The most powerful force in the universe is compound interest.” Understanding how compound interest works will definitely help you to meet your investment goals.
Most people have this imagination in their mind where they will somehow be able to be pensioned off young without actually investing any time or money. Well, let this be a wake-up call for you. The more time you are willing to commit to your investments, the easier it will be to achieve your retirement goals. You should use the Rule of 72 to your advantage. If a 20 year old invests RM100 every month until he reaches the age of 65, he will have nearly RM465,000 if the annual rate of return is 8% upon retirement. If the same person postponed his investment and only start when he is 40 years old, he would need to invest an amount of RM529 per month to achieve the same outcome. On the other hand, if that person decided to invest the same RM100 per month, he would end up with only a miserable RM87,750 by the age of 65. It is best to contribute habitually now and contribute enough so you will not be rolling the dice as you are approaching retirement. Hence, use the rule to find out what is the best interest rate for your investment which will then help you to achieve your retirement goals.
Choosing the correct interest rate
Based on the chart above, it shows the amount of years needed to double the amount of investment given various annual interest rate. Constructing the table above using the simple formula will enable you to select the best interest rate based on the number of years you would like to get your returns back. Besides being able to plan your investment wisely, you will also have a better idea of what and how to spend your money sensibly in the near future.
The ‘Rule of 72’ is an easy rule to remember and correspondingly a very useful formula for every investor. This rule taught us that over time small amounts add up whether it is savings or investment returns. Besides that, personal finance is really about basic math and it is important to know that we should always spend less than what we make and save the rest. As the saying goes, better late than never. It is never too late to start saving now and we hope that this rule will help you to identify the right investment option for you to achieve your target well ahead of time.
Don’t miss "Rule of 78" to learn more about the secret of your loan’s interest!