Calculating Interest 2.5: Rule of 72

Instead of moving on to Calculating Interest 3, this post is a bonus. It follows on Calculating Interest 2: Compound Interest.

The Rule of 72 enables you to estimate compound interest in your head. It answers the question: How many years will it take for my investment to double in value?

Here is the formula: 72 divided by Rate of Growth equals Number of Years to Double in Value.

For example, if I can get a 6% compound interest return, my money would double every 12 years. 72 divided by 6 equals 12. So if I invested $10K, then in 12 years, I’d have $20K. At year 24, my money would double again, so I’d have $40K. At year 36, I’d have $80K.

I can also flip formula around: 72 divided by Number of Years to Double in Value equals Rate of Growth. For example, if I want to double my money every 8 years, I’d need to find an investment that produces a 9% compound interest return. 72 divided by 8 equals 9.

I can use this to calculate debt. If I put $10K on a credit card at 24% interest and never paid anything back, I’d owe $20K in only 3 years. 72 divided by 24 equals 3. If I continued to never pay that debt off, I’d owe $40K after 6 years, $80K after 9 years, $160K after 12 years, $320K after 15 years, $640 after 18 years, 1.28M after 21 years, etc. So if you want an extra 1.28M in 21 years, then pay off your $10K credit card as soon as you can.

And you can also use it to calculate inflation. If a peanut butter and jelly sandwich costs $1 today, and inflation is 3%, then that PB&J will cost $2 in 24 years, $4 in 48 years, $8 in 94 years, etc. (By the way, true inflation is much higher than 3%: http://www.shadowstats.com/alternate_data/inflation-charts.)

What do you think?
Joseph

This is a series. Here is the previous post. Here is the next post.