Rule 72: What Is It for and How to Use It?
This overview is devoted to such a method of assessing investments as Rule 72. We will see how it works and how it can be used.
Rule 72 is a simplified calculation method that shows how fast your investments will double if the profitability remains stable. Calculation of complicated percentage (profitability of constant reinvestments) is a really difficult mathematical operation that makes most people grab a calculator. Hence, for less accurate calculations, right on your lap, investors use Rule 72.
By this method, any person can simply count in their mind and fancy the magic of complicated percentage.
If you want to know how much time you will need to double your assets if the interest rate remains set, this Rule is the fastest option. It was for the first time mentioned in the works of an Italian mathematician Fra Luca Bartolomeo de Pacioli.
The mathematical formula for Rule 72 looks as follows:
T = 72 / R
T is the time during which the capital be doubled;
R is the interest rate.
When it comes to assessing the errors of such estimations, you get better results when the interest rate is about 8%. Nonetheless, you can feel confident when the interest rate is between 1% and 15%.
When the profitability is higher than this, the calculation becomes too inaccurate. In the end, nothing can be compared to the real calculations of complicated percentage with special calculators.
For example, let us put various interest rates to the formula. The method is applicable to banking accounts, bonds, and more. If the interest rate is:
- 1%, the capital will double in 72 years (72/1 = 72);
- 2% — in 36 years (72/2 = 36);
- 5% — in 14.4 years (72/5 = 14.4);
- 8% — in 9 years (72/8 = 9);
- 15% — in 4.8 years (72/15 = 4.8).
There are several main ways of using Rule 72 in finance:
- Calculation of capital doubling time: the main task of the rule is assessing how many years it will take the capital to grow twice when the yearly interest rate is set (acceptable accuracy is between 1% and 15%).
- Profitability calculation: the formula can be used vice versa as well, assessing which yearly interest rate is necessary to double the capital over a certain time. For example, to find out which interest rate we need to double the capital in 6 years, you just divide 72 by y = 12%.
- Assessing inflation influence: it helps to understand how inflation decreases the capital if it just lies idle and brings no profit. For example, let us see how long it will take your savings under the mattress to become 2 times smaller when the yearly inflation is 6%: 72/6 = 12%. 12 years later, if inflation is stable, you will be able to buy twice as less goods and services than now. From some $10,000, you will only have $5,000.
What is the difference between Rule 72, Rule 70, and Rule 69
Apart from Rule 72, you can use Rule 70 and Rule 69 with the same goals. These rules help to simplify calculations or calculate more accurately depending on the period of interest payments.
For example, Rule 69 is most accurate when interest is paid daily. For monthly and annual payments, Rule 72 is normally used. Rule 70 is applicable for the sake of simplicity.
Anyway, each of these rules can be used for fast calculations with a set and relatively low error level. Choose the rule that is better for your goal.
Rule 72 is a simple and comfortable way of calculating the attractiveness of investments right in your mind. This is quite an innacurate way that makes certain errors but gives an opportunity to assess the profitability of investments without going deep in maths.
However, it should be remembered that the market is full of various factors that influence the efficacy of investments and skips the rule.
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