Tuesday, May 20, 1997
[Today, we revisit a classic fribble from May 1995]
The Rule of 72
by Mike
Buckley
Have you ever wondered how long it'll take your "Beating the Dow" portfolio to double if it grows at the BTD's historic rate of about 20%? Or, ever wonder what your average annual return has to be if you want your stock to double in 10 years? In 5 years? Of course you have -- enquiring Foolish minds want to know these things!
The good news is, you don't need a fancy calculator, a zippy spreadsheet, or mind boggling gobbledygook of any sort. You can figure it out in your head while you're jogging or watching Star Trek reruns. Just use the "Rule of 72."
Very simply, the Rule of 72 allows you to figure in your head the approximate number of years required for your investment to double with varying growth rates. Take your BTD portfolio. Say you want to know when it'll double if it grows annually at 20%. Simply divide 72 (the magic number) by 20 (the growth rate) and round to the nearest integer. Whether Foolish or Wise, you know right away that 72 divided by 20 is rounded to the number 4. That means it takes about 4 years for your BTD to double at a 20% annual return.
What if you "only" earn 15% a year, still beating the Dow's average 10% return by a whopping one-half? Decide for yourself. Divide 72 by 15 and round the answer to the nearest integer. See how long it'll take your BTD to double then. (Hint: It's not terribly long, either.) What happens, by the way, if you accept 3% a year on your savings? Very safe on your part, but how long is 72 divided by 3?! Ouch.
The Rule of 72 also lets you figure the rate of growth you'll need to double your investment in a specified number of years. Say you want to know the rate at which your investment has to grow if it's to double by the time your child goes to college 7 years from now. Easy! Divide 72 (that magic number) by 7 (the number of years) and round to the nearest whole number. None of Einstein's genes are needed to figure out that 72 divided by 7, and rounded, is 10. Your investment would have to grow about 10% annually to double by the time tuition payments start.
The simple Foolish math is this: approximate number of years to double = 72 / rate of growth. Approximate rate of growth to double = 72 / number of years. Don't forget to round answers to the nearest whole number. Why does the Rule of 72 work? There's a Foolish Monthly Quiz question for MF Swagman and his band!
Of course, the results you get with the Rule of 72 aren't precise to the last decimal. But, like the Pentium chip, they do get you into the mathematical ballpark quickly and simply, and that's why (along with Catch 22) the Rule of 72 is my favorite. Besides, being a card-carrying Fool who believes in long-term investing, it reminds me that doubling my money requires investments measured in years, not months. And that Foolish perspective is what counts most.
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