The Rule of 72
How do people calculate complicated financial formulas so quickly in their head?
One "trick" is the "The Rule of 72" which is a quick way to estimate how long it will take for your investment to double at a fixed rate of return. Simply stated 72 divided by the rate of return equals the number of years your money will take to double.
If the annual return on an investment is 6 per cent, how long will it take to double? Divide 72 by 6. You can expect your money to double in about 12 years if you invest it at 6%.
If you can remember algebra from school you'll remember that you can mix the formula around to answer different but related questions.
To work out how long it will take for inflation to halve the value of your money you divide 72 by the inflation rate. For example, if inflation is 3 per cent, the value will halve in 24 years.
If the value of your investment has doubled in 10 years, how fast did it grow each year? Divide 72 by 10. It grew about 7.2 per cent a year.
Yes I know I've picked easy numbers in those examples, if the rate of return is 4.8% you might have trouble doing that in our head, so here's another trick, did you know most cell phones have a calculator?
By the way the answer is 15. Its a number I remember from the 1980s when someone was offering 15% and telling us "compound your interest and double your money in less than five years". Mind you inflation was 13% or 14% and you were probably paying 16% or even 18% on your mortgage.
If you weren't around in the 80s or can't remember back that far have a look at some of the long term historical statistics at Statistics New Zealand website http://www.stats.govt.nz/browse_for_stats/economic_indicators/NationalAccounts/long-term-data-series/finance.aspx.
Note that the rule of 72 is a mathematical approximation. It works pretty well with percentages up to around 15 per cent. As the percentage gets higher it gets less and less accurate.
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