The rule of 72 is a shortcut to calculate how many years it will take for an initial investment to double based on the expected interest rate. It’s best explained through an example. Say you have $1,000 to invest and you expect a 9% return. Using the rule of 72 you can solve for roughly how long it’ll take for you to have $2,000. Simply take 72, divide it by the interest rate (9% in this case) and the answer, 8 years, is how long it’ll take for your money to double. Let’s try another. Take a 3% interest rate, 72/3 = 24. So, 24 years is how long it would take that $1,000 to double to $2,000. That should make sense, 9% is three times that of 3% so it only takes 1/3 of the time to double. Over time is where compound interest starts to get crazy. Say you invested that $1,000 at the 9% return for 24 years (the time it takes the 3% to double). You have $8K. While the interest rate is only 3X greater, at the end of the 24 years the $1,000 has grown 8x. And if you kept it invested for another 6 years, that $1K would now be nearly $15K.
Now that we can use the rule of 72 to quickly calculate how long it takes an investment to double. And now that we have a comprehension of how doubling over time adds up, let’s look at how it impacts decisions you make regarding your personal finances. There is a reason I picked these specific numbers. Current mortgage rates in the US range between 2-4%, meanwhile the average annual return of the S&P 500 since 1926 is around 10%. When you include dividends it is closer to 11%. So 9% is a slightly conservative growth rate. While it seems weird to take a loan out on your home rather than using cash so that you can instead invest that money, mathematically it is the better decision. Now this isn’t to say that paying off your mortgage quickly is wrong, just that mathematically investing that money instead will on average yield much better returns. While your mortgage payment is due rain or shine, the market is highly volatile. The S&P dropped over 40% in a period spanning 2008-2009. However, over a 20-year timeframe the worst ever 20-year period delivered an average annual return of 6.4%. Still double that of current mortgage rates. The point here is to make sure you are maximizing your retirement accounts before prioritizing paying off your mortgage. The opportunity cost of not investing and instead prioritizing paying off cheap debt is actually quite substantial.
How does the rule of 72 plus the power of compound interest impact retirement planning? Assuming a 9% annual market return, you can expect your investment to double roughly every 8 years. One dollar saved and invested today is worth $2 in eight years, $8 in 24 years, $32 in 40, and $64 in 48 years. If you are a 20-year-old. Every dollar you can invest now will be worth $32 when you are 60 and ready to retire. If you’re 30, that dollar will be worth $23 when you’re 65 and as a 40-year-old, it’s not too late, every dollar invested today is worth $12 for you to retire at 68.
So, to literally quote myself from my power of compound interest article “Don’t wait, start now, invest in yourself today! For only $16 a day, YOU can set yourself up for retirement. No catch or gimmicks just let the power of compound interest work its magic.”
Source for the S&P 500 rolling returns – a fascinating read if you’re a finance nerd like me https://www.thebalance.com/rolling-index-returns-4061795