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Rule of 72: Doubling Your Investment with Compound Interest

Rule of 72: Doubling Your Investment with Compound Interest

When investing in the stock market, The Rule of 72 can be a helpful tool to give you an idea of how long it will take for your investment to double in value. It can be used to calculate the potential doubling in value as long as your return is consistent each year, and only works with compounded rates. The rule doesn't apply if the investment offers a variable rate of return.

Compound interest is interest on top of interest. When future interest accrues, you're getting interest on the interest you've already earned. The more you're able to take advantage of compounding, the more wealth you stand to accumulate.

Thankfully, calculating the formula is pretty straightforward. Simply divide 72 by the interest rate you expect to earn on an investment. If you expect to earn 9% return on your investment, it will take 8 years for your money to double (72/9 = 8). The Rule of 72 is reasonably accurate for interest rates that fall in the range of 6% and 10%.

Once you know how long it takes your money to double, you can use that to figure out how many times your invested money can potentially double within a certain period of time. For instance, if you're saving for retirement and expect to retire in around 24 years. the Rule of 72 would estimate that your money would double three times within that timeframe with a 9% annually compounding interest: 24 (years until retirement) / 8 (doubling frequency) = 3 doubling periods.

To illustrate further, with 24 years to go, every $1,000 you invest could potentially be worth around $8,000 when you tap it to spend for your retirement. After one doubling period, that $1,000 would be worth $2,000. After a second, the $2,000 would be worth $4,000, and after the third, the $4,000 would be worth $8,000.

The benefits of the Rule of 72 and annually compounded interest is one of the most powerful reasons for starting to invest early in your career. If you are able to invest for 40 years and earn a 9% annual rate of return, that's enough to turn every $1,000 investment into $32,000 in five doubling periods.

Factors which can affect the actual length of time it takes for an investment to double can include:

  • Volatility of returns
  • Inflation
  • Fees

In conclusion, the longer you wait to start saving and investing, the less opportunity you'll have to take advantage of compounding and the doubling effect of The Rule of 72.