Source:
Sherman Publications
Raymond James: A column by James Kruzan
The Rule of 72
September 29, 2010
“How long will it take my investment to double?” This is a common question many may have concerning their investments and think a calculator is needed to provide an answer. But a calculator may not be needed, at all.
The tool to use is called the Rule of 72 and, best of all; it is simple and free. This is how it works. If an individual has an investment they think will grow at an assumed rate of return per year, then simply dividing that rate of return into 72 will provide a rough estimate of the number of years it will take for the investment to double in size.
For example, let’s assume an investment is assumed to grow at an average rate of return of six percent each year. Simply divide six into 72 will give a rough estimate that it will take 12 years for this investment to double (72 / 6 = 12). This formula assumes a fixed annual rate of return and the reinvestment of all earnings. Keep in mind that very few investments offer a guaranteed rate of return and that an investment’s past performance does not guarantee future performance.
The rule of 72 may also be used to show the negative power of inflation. This may be an especially handy tool to those individuals in their retirement’s years and, also, for those approaching the retirement decision. Using this tool an individual can estimate the number of years it will take for his or her cost of living to double. Or put another way, how long before an individual’s purchasing power is cut in half.
For example, let’s assume an individual is retired and forecasts an inflation rate of five percent per year. An inflation rate, in general terms, is the rate of increase in the prices of goods and services individuals purchase over time. Forecasting an inflation rate of five percent means the individual is assuming the prices of the goods and services he or she will purchase in the future will increase at a rate of five percent per year. Using the rule of 72, simply dividing five into 72 will provide a rough estimate that the individual’s cost of living will double in 14 to 15 years (72 ¸ 5 = 14.4).
James B. Kruzan, CFP, is a Registered Principal and Branch Manager for Raymond James Financial Services, Inc., Fenton and Clarkston.