When I first started working at P&A in 2001, I remember Pitt taking me along to a meeting where he discussed the “Rule of 72.” Unlike some financial “rules,” this one doesn’t require an advanced degree to understand. The math is quite simple. If you want a back of the napkin way to determine how long it will take to double your money given a certain projected annual return, do the following:
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- Take the projected annual return and divide this number into 72. The answer will be an approximation in years
- At 7%, it takes roughly 10 years to double your money.
- At 10%, the timeframe is closer to seven years.
- At 4%, it will take 18 years to double your money.
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Risk and return are joined at the hip. To earn a higher return, you must take more risk. Every client has a unique tolerance for risk. We use a client’s risk tolerance to determine an appropriate investment mix, which we call an asset allocation. Generally, the more equities in the account, the higher the return will be over time, and thus the more quickly the investor’s money will double, based on historical returns.
The Rule of 72 also assumes that the investor isn’t jumping in and out of the market. Time IN the market is essential to allowing the Rule of 72 to do its thing. We should point out that the math of this rule doesn’t account for additions to an account over time or the impact of inflation on what those dollars can buy in the future.
One of my favorite accounts at P&A–and I use the term “favorite” here lightly ONLY because it was a one-time deposit with no additions or subtractions by the client in nearly 20 years. The initial deposit of $500,000 happened in June 2003 and by December 2021, the account value had risen to nearly $3 million dollars. The account had the benefit of starting right after the tech bubble burst, but it also survived the financial crisis of 2008-2009 and the COVID pandemic plunge and quick recovery.
We’ve talked before about the power of compound interest and the importance of time in the market. Both allow for the Rule of 72 to exist, which is a great shortcut for quickly determining roughly how long it will take your money to double. I also think this is a great tool to motivate a young saver to put money away for the future. When they see the potential growth of these dollars over time, they may be more inclined to start early.
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