The Rule of 72 explained.

The rule 72 is a simple way to determine how long an investment (your capital) will take to double given an annual rate of return. It is a great way to see the effects on your capital with a yield that is known whether it be from dividends, fixed bank rates or bonds. I also use it as an “estimation” only on potential investment ideas if I am modelling ROIC (just for curiosities sake). It is best used for anything that grows at a compounded rate.

The Rule of 72 all though simple is a powerful way to show what small changes annually can make. 1% changes over longer periods of time have a very real impact on the final number. It is handy when looking at inflation, GDP growth and what investment fees can do to your total returns over the long term.

The formula also works in reverse if you want to double your money in a given time period you can reverse it to reflect the likely annual rate needed to achieve that return.

The Rule of 72 works best in the range of 5 to 12 percent, but it’s still an approximation.

What is the Rule of 72 formula?

How to use the Rule 72 Formula?

Let us work out an easy example. Let’s say we have a fixed interest rate with a 5% yield. It would look like this (72÷5 = 14.4). So it would take us 14.4 years for our capital to double.

Let’s reverse this to show the opposite example where we want to know what annual rate of return we need to double our money. If we have $100,000 and a 7-year time frame to invest it and we want to double our money in that 7-year period, we will simply replace the Rate of Return with the Years-to-double to look like (72÷7 = 10.28). So, we would need an annual rate of return of approximately 10.28% to double our capital in 7 years.

Below is a chart showing the annual rate of return against the years required to double your capital to give you a visual of what higher rates of return can do to your portfolio. If you ignore this from an investment perspective just look at the difference of what 1% can look like. Inflation and professional management fees can do real damage over decades!

It is truly amazing when we look at successful fund managers who have delivered CAGR of 20% or more for decades. This is where the power of compounding can come in. Holding an investment for 10-years at a CAGR of 20% doubles your capital roughly every 3-4 years.

*As a rule of thumb, personally I aim at doubling my own capital every 4-6 years which leaves me working between the 12-15% returns annually as a benchmark.

In Summary…

Whilst this is not an in-depth formula nor something I use often; it is a rule every investor should know to help reframe the way you think in terms of capital allocation and returns over the years. I am a long only investor, so I find this rule a lot more useful when measuring opportunity costs against different investments. It can be used as a very rough guide when measuring a business and looking at the likely returns aligning with the companies ROIC or ROE.

Whilst your capital won’t always grow at the same rate as the companies you invest in, it is often closely tied to it. If a company has an ROIC of 15% over a long enough time frame I typically estimate my own capital to also compound at close to this rate (this is not a science but a guestimate).