The Rule of 72

This rule of thumb is one of my favourites. It’s a quick way to calculate how long it will take for an investment to double in value and can be used to prove how modestly better returns can lead to dramatically better outcomes over long time periods.

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You know, I was first exposed to the “Rule of 72” in my second year of university. This will make me sound like a complete financial geek. I am one, but it was love at first sight. The rule simply states the years to double your money = 72 divided by the rate of your compounded-annually rate of return. So, if you grow your money at 8% compounding annually, it’ll take you 9 years to double your money–72 divided by 8. If I lost you there… At 12% it would take you only 6 years–72 divided by 12. At 6%, obviously it would take you 12 years. At 72% it would take you only one year.

Whoops, that’s not right. Obviously you need 100% return to double your money in one year. Hmm. Maybe “The Rule of 72” will be more appropriately called “The Guideline of 72 that doesn’t work that well for extreme rates of return.” Regardless, the rule does provide a very good approximation of doubling times for rates from 2 to 18%. Applied to higher returns and it gets a bit wacky. But, hey, if you’re consistently compounding your money at more than an 18% a year return, I should be watching your videos, not the other way around. Now, let’s have some fun here. Let’s say you were starting out with $10,000 in your TFSA. You invest the money without learning the basics or developing a plan.

Over the years, you pay very little attention to cost, and on several occasions you let your emotions get the best of you. In short, you act like most investors. You go on to average a 4% rate of compounded return. Your best friend, who invests $10,000 at the same time, manages to mix together common sense and discipline and averages an 8% return compounding annually.

“Whatever,” you think. “Okay, so what? She ends up with a little bit more money. Good for her. She’s great. No biggie.” Actually, you’d be right if you were talking about a one-year time frame. You’d end up with $10,400 obviously. She’d have $10,800. What’s $400 between friends? She’d probably take you and your spouse out for a nice dinner. Ah, but what if the money was left alone for 18 years? You’d have $20,000 because at 4%, money doubles every 18 years. She’d have $40,000! Yep, at 8%, money doubles every 9 years–2 doubles, and presto, $10,000 is $40,000. How can that be? You both worked equally hard and made the same sacrifices to save the original $10,000.

It’s not fair. And it gets worse. 36 years in, nearing retirement, things have turned downright ugly. Your original $10,000 is now $40,000 (10 x 2 x 2). Hers is now $160,000 (10 x 2 x 2 x 2 x 2). You’re dog-sitting for her while she and her partner travel through the vineyards of Northern Italy for the second time in six months. “We just had to see them in the fall,” she explains. Seemingly modestly better returns make for a dramatically better retirement, and “The Rule of 72” proves it.