A horseback method for estimating the doubling effect of compound interest.
The 72 rule or rule of 72 is a shortcut way of comparing different interest rates. It is a way to determine how long a given interest rate takes to double your money. It is a substitute for using a math equation for doing the calculation. Because it is a shortcut it is not as accurate as the math method, especially for larger interest rates.
If you have an interest rate that you know that your money is going to compound at, then you can simply divide that interest rate into the number 72 to get the number of years required to double your money.
You can also do it the opposite way. If you want to double your money is a certain number of years, you can divide the years into the number 72 to get the interest rate needed to reach your goal.
Find out how fast your savings will grow. If your savings are invested at 5% annual interest, then you will have double money in 72/5=14.2 years.
Calculate the depreciation of your savings with inflation. If the inflation rate is 4%, then the buying power of your savings will halve in 72/4=18 years.
If you combine the above 2 examples you can see how fast your true buying power will increase. 5%-4%=1%; Your buying power would double in 72/1=72 years.
You want to double your money in 8 years. What interest rate do you need to accomplish your goal? 72/8=9% You will probably need a riskier approach to achieve this return.
The same rule of 72 can apply to loans as well. If you have a 25% interest rate loan that you don't make payments to, then the amount owed will double in about 3 years.(The rule of 72 gives 2.95 years and the interest rate formula gives 3.1 years)
The 72 rule is a quick and easy way of figuring out how fast money will grow with interest. This is the power of earning interest on interest. Albert Einstein is quoted as saying that compound interest is the 8th wonder of the world.
