Have you always wanted to be able to do compound interest problems in your head?
Probably not…..But it is a very useful skill to have because it gives you a lightning fast benchmark to determine how good (or not so good) a potential investment could be.
The rule of 72 allows you to do a quick and accurate compound interest calculation in your head.
It works like this.
The rule says that to find the number of years required to double your money at a given interest rate, you just divide the interest rate into 72.
For example, if you want to know how long it will take to double your money at eight percent interest, divide 8 into 72 and you get 9 years.
If you earn 10 percent, you double your money in about 7.2 years (72 divided by 10)
If you earn 15 percent, you double your money in about 4.8 years. Check out this table:
(We're assuming the interest is compounded at the end of each year, by the way.)
As you can see, the "rule" is remarkably accurate, as long as the interest rate is less than about twenty percent; at higher rates the error starts to become significant.
How else can you use it?
You can also run it backwards, to estimate the “doubling time”.
If you want to double your money in six years, just divide 6 into 72 to find that it will require an interest rate of about 12 percent.
You want to double your money in 10 years? You’ll need to earn about 7.2% (72 divided by 10)
How easy is that?
It’s also useful to estimate the ‘decaying’ power of inflation. For example, how many years will it take for inflation to halve the purchasing power of your money. Assuming 2.5%, it will take about 29 years (72 divided 2.5). Or look at it another way, in 29 years you’ll need to double today’s income to have the same purchasing power.
Learn this tip and put it in your tool box. It really is useful and something I use just about every day.
Let me know what you think.