In general, the "Rule of 72" gets you quite close to the actual figures, though it may become pretty inaccurate once interest rates are at 20% and higher. If you're able to achieve such interest returns on an annual basis over a long period of time, it's safe to assume you will be able to derive such complicated calculations on your own.
Applications of Rule of 72
The Rule of 72 could apply to anything that grows at a compounded rate, such as population, GDP growth and even inflation, investment returns or fees.
For most, returns and fees are important figures you may want to calculate before making an investment. You can use the table above to estimate how long your investments will take to double, and how long more you need if you factor in annual investment fees.
The rule can also be used to find the amount of time it takes for your money's value to halve due to inflation
. If inflation is 6%, then a given purchasing power of the money will be worth half in around (72 ÷ 6) = 12 years. If inflation decreases from 6% to 4%, an investment will be expected to lose half its value in 18 years, instead of 12 years. This is also another important reason to invest, and to receive an investment return that beats the inflation rate.
What can the "Rule of 72" teach us?
The Rule of 72 depicts how even a "small" 1% difference in inflation, fees or investment return can have a large effect in forecasting models. If you wish to double your money, receiving a single percent less can extend the number of years you need to reach your goal.
This also highlights the importance of carefully evaluating the potential returns of each investment product, after accounting for fees and costs. These differences can add up significantly over the long run and have a big impact on your retirement plans.
Secondly, the rule elegantly illustrates the "magical" power of compounding. If you diligently invest and receive even a modest rate of return (4% to 5%), you can actually double your initial capital in less than two decades.
In order to allow this compounding to work, all that's needed is time and diligence. By planning for one's retirement early and starting to invest today, you can ensure you're growing your retirement nest egg so that it will be ready for your retirement needs in your golden years.
Someone who starts investing only in their forties may need to contribute many times more money to their retirement funds, but will still not have a larger retirement nest egg compared to someone else who started in their thirties or even twenties. This is because they were not able to leverage on time to compound their investments.
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