Financial independence is having enough income to pay your living expenses for life without having to be employed for salary or depend on others for handouts or loans. The rule of 72 simply computes how fast your money grows given an investment return over a period. It is one of the most useful “must-knows” for every avid investor aspiring for financial Independence. This is because it demystifies your ability to become financially independent and estimate the number of years required at a given rate of interest to double up your investment amount at any given rate of return. This helps you plan your investment decision wisely without the complexities of financial calculators.
When the rate of return on your investment is known
Assuming your rate of return on an investment is 6% and you want to know how long it will take for you to double any investment amount you invest at the said rate. Divide 72 by the agreed rate (which in this instance is 6%). The answer you get from this exercise gives you the number of years it will take to double your investment.
In this example, if you invested GHC1,000 into an account that earned a flat 6% annual rate of return, your rule of 72 calculation will be 72 divided by the given rate of return: 6%, (72/6). The answer is 12. This means at 6% per annum, your investment would double to GHC2,000 after 12 years.
When your recommended holding period is known
In instances where you do not know the exact rate of return, but you have an idea about the number of years you want to see your investment income for financial independence. The rule of 72 can be used in reverse. The investor can use the rule to discover the compound annual growth rate (CAGR) they would have to earn to achieve their investment income goal.
In this example, let’s assume the number of years estimated to double your income is 4 years. To estimate the rough rate of return required to achieve this feat, you divide 72 by 4. The result in this case is 18, representing 18%. In essence, you will need an investment with the approximate return rate of about 18% (after tax compound annual rate of return) to achieve the doubled investment income goal.
That is a simple way to calculate earnings, but it be helpful in determining whether there is a gap or potential shortfall in your savings strategy in your bid to achieve your investment goal. The Rule of 72 can thus help you gauge whether your current savings plan is sufficient for reaching your short- and/or long-term goals.
The Rule of 72 by Interest Rate
Since interest rates can vary, the Rule of 72 calculation can produce different results, based on what you have invested in and the promised or guaranteed rate of return.
To save you a little time, here are some common interest rates, plus the amount of time it will take for you to double your investment with each interest rate.
|Rate of Return||1%||2%||3%||4%||5%||6%||7%||8%||9%|
|Rule of 72||72/1||72/2||72/3||72/4||72/5||72/6||72/7||72/8||72/9|
|No. of Years||72 years||36 years||24 years||18 years||14 years||12 years||10.3 years||9.0 years||8.0 years|
Remember, this is an Estimated Value
Depending on changes in the rate of return over time, the investment instrument you are invested in, how you invest it, how interest is applied, and possible tax implications, the actual amount of time needed to double your money will vary. Even so, the rule of 72 can be helpful when you quickly want to compare the rate of growth of two investments; say; a property investment, a retirement fund, an equity fund or an emergency account. You can easily see at a glance which one is likely to yield a better rate of return to decide where the best place is to allocate your money.
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