The Rule of 72

If you have given any thought to a savings goal for a comfortable retirement, you have also probably wondered how long it might take to reach that goal. That can depend on many factors but using the Rule of 72 is a quick and easy way to determine how long it may take for your savings to double using a specific rate of return, and then you can extrapolate from there. Contrary to what it may seem, the Rule of 72 has nothing to do with your age, or with Required Minimum Distributions (RMD's) that typically start at age 72. Instead, it is an adaptation from a logarithm used to calculate compound interest that was first published in the 1400's. Technically, using 69.3 rather than 72 is more precise, but because 72 is divisible by more whole numbers, is seen as being more user friendly, and only changes the results by a matter of days or months, it has become the more common number to use.

Here's how the Rule of 72 works - if your savings are expected to earn 6% annually (for example), divide 72 by 6 (answer: 12) and that's roughly how many years it will take for your money to double. At a 10% rate of return, your savings would double in approximately 7.2 years.

The results from this rule are approximate, but are, as the saying goes, "close enough for government work". The higher the return rate used (specifically, greater than 8%), the less precise the rule is, but even at a 15% rate of return the results are off by just a couple of months. It still works well even at a 25% rate of return (should you be so fortunate).

Another benefit of this rule is that it also works in reverse. If you want to double your savings in a specific number of years, just divide 72 by the desired number of years to determine the rate of return that will be needed to reach that goal. For example, if you want to double your savings in 8 years, divide 72 by 8 (answer: 9), to show that you would need a 9% rate of return to accomplish your goal.

There are, of course, plenty of calculators that can give you a very precise answer (down to the number of days) to these types of questions, but unless that degree of precision is necessary the Rule of 72 allows you to do it yourself with very quick and simple math. One caveat - remember that this assumes a perfectly consistent rate of return for many years in a row. Any deviation in those returns will affect your results accordingly. Considering the annual fluctuations in the financial markets, using a realistic and conservative average rate of return rather than a more optimistic rate may offer better accuracy in the long run.

While the Rule of 72 is undeniably convenient for quick figuring, it is just a starting point. If you want to know with more certainty how long it will take for your savings to reach a specific goal, not just double, creating a comprehensive financial plan will show you savings growth year by year. More importantly, it will provide those detailed annual results using only your personal financial details (i.e., income, expenses, taxes, etc.) not broad, generic assumptions. It will also offer the opportunity to use varying annual return rates, which will be more realistic than using the same rate of return for every year. As always, quick rules of thumb are fun, but if you want the most reliable information, be sure to use the right tool for the job.

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