How can we generate more money? Capitalizing on our savings. For how long? The rule of 72 tells you how many years it takes to double them.
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Rule of 72. This is a rule of thumb that is even considered a successful formula for monetizing savings. It can be a good basis for monetizing your nest egg, creating good financial habits and achieving your goals.
After all, what is the rule of 72?
The Rule of 72 tells you how many years it will take for the money you’ve been saving or investing to double at a given interest rate when you factor in compound interest.
Why 72? Because someone did a lot of math and found that the percentage of interest times the number of years it takes the initial principal to double is approximately 72.
By applying this formula you will have an approximate idea of how much your investment can grow over time, without having to do complicated calculations.
And how is the formula applied?
The Rule of 72 formula is as follows:
72 / Interest rate = Number of years required to double capital
That is, to know the number of years it takes for the money in the bank to doublein deposits, in capitalization insurance, in bonds and others, just divide the number 72 by interest rate received from these investments.
Let’s see an example
Let’s think of an interest rate of 10% per year. According to the Rule of 72 application, a financial investment with an interest rate of 10% will need 7.2 years to double the money initially invested.
If we are more realistic and think of a term deposit with an interest rate of 2%, it will take exactly 36 years to double the initial amount invested in that deposit.
How important is the rule of 72 for your savings and investment decisions?
Estimate the term for a particular investment or savings
The Rule of 72 is a rule of thumb that serves to estimate how much you can earn in a given period of time with the money you save or invest in the financial instruments at its disposal. But it goes further.
Find the ideal interest rate
This rule can be applied not only to find out how long it takes to double an investment, but also to find the interest rate needed to double a given amount in a given number of years.
Imagine you have money to invest, but you can only invest up to a certain number of years. You can use the rule in reverse and predict the interest rate that can double your money in the number of years you set.
Significantly improve your financial planning
Knowing when your money can double and at what rate it can do so over a given number of years can be a big help in financial planning.
The Rule of 72 allows you to determine, for example, when to buy a house or to take a trip. It can even help you get an idea of when to retire. It is also useful for deciding which financial products are most convenient to apply your savings.
What is compound interest and how is it calculated?
Compound interest doubles your savings and investments faster than simple interest. Compound interest is the opposite of simple interest.
When we say that interest is compounded, it means that interest grows continuously. Imagine a balloon without air and also imagine another balloon being inflated continuously. In the world of finance, the air the balloon gains means interest earning interest over time. The result is faster growth for the money you initially invested.
Calculating compound interest
This faster growth is due to the incorporation of simple interest in the initial capital. On top of this capital plus interest, more interest is added successively. When a financial application earns interest, these are added to the capital and this sum forms a new capital superior to the initial capital on which interest falls.
Let’s think of a financial application that yields 5% interest and an investment of 1000 euros over 3 years. The calculation of compound interest would be done as follows:
- First year: €1000 + €1000 x 0.05 = €1050
- Second year: €1050 + €1050 x 0.05 = €1102.5
- Third year: €1102.5 + €1102.5 x 0.05 = €1157.6
The rule of 69
Some statisticians prefer to use the number 69 instead of 72. They feel that the result obtained using the number 69 is more accurate than using the number 72.
So, in addition to the Rule of 72, you can also try applying the Rule of 69. The formula is exactly the same. Rigors aside, both rules have a simple calculation. As you can see, you don’t need to be a math expert to apply it.
Article originally published in November 2020. Last updated in March 2023.