Updated: October 5, 2020
What is the “Rule of 72” and why do many financial advocates use it to convince people to invest? Today, we’ll take a closer look at this concept.
The Rule of 72 is used in personal finance as a shortcut to calculate how many years an investment will double in value, given a fixed annual growth rate.
It states that if you divide the number 72 by the growth rate, you’ll get a rough estimate of the number of years it will take for the initial investment to become twice its value.
For example, if you have P20,000 in the bank which earns 1% per year. Then it will take 72 years for your money to double or become P40,000.
That’s because 72 divided by 1 (the growth rate) is equal to 72.
What if you put that P20,000 in an investment that grows by 12% per year?
Since 72 divided by 12 is equal to 6, then it will take about 6 years for your money to become P40,000.
Who invented the Rule of 72?
The “invention” of the Rule of 72 is usually attributed to famous theoretical physicist, Albert Einstein.
However, this is a myth. The truth is that there’s no evidence that links Einstein to the rule and there’s no mention of it in any of his works.
Interestingly, an early reference to the rule is in Summa de arithmetica (Venice, 1494. Vol. 181, n. 44). It’s a book written by the Italian mathematician, Luca Pacioli (1445–1514).
Is the Rule of 72 accurate?
The short answer is NO. However, for low rates of return, the Rule of 72 gives a fairly accurate result. Here’s a table that shows how close the results of the Rule of 72 are to the actual figures.
Why use the Rule of 72?
Because it gives you a quick way to see how your money can grow. Looking beyond its inaccuracy, the rule efficiently demonstrates the power of compounding, and the importance of investing.
To illustrate, let me ask you… would you like your money to double after 72 years? Or would you rather have it double every 6 years instead?
Of course, the better choice is obvious… we go for the 6 years, which by the Rule of 72, refers to an investment that grows at 12% per annum.
Is there such an investment? Yes, several companies in the Philippine stock market have in recent decades, grown by 12% or more per year. One of them is my favorite stock, Jollibee (JFC).
The reason why the actual stock price is higher is because the compounded annual growth rate of Jollibee is in fact, more than 12% since January 1994.
Please note that not all companies in the Philippine stock market have a growth rate of 12% or higher. Most of them actually have much less, that’s why it’s important to choose the right company when investing in the stock market.
How about the Philippine Stock Exchange Composite Index? Since its inception in January 1985 until January 2018, the PSEI has grown by around 14.5% per year.
Let’s see how it compares to the Rule of 72.
The value of the PSEI in the table above is a good example of how volatile the stock market can be. Of how much it can go up and down through the years.
However, you should realize that for the long-term, prices can and will eventually go up. And if we are to follow the Rule of 72, you can see that it has always grown by more than 12% since it started in 1985.
Personally, I also use the Rule of 72 to quickly estimate how much an investment has grown through the years. It allows me to have a fair evaluation if an investment is appropriate for my needs or not.
For example, if my financial goal requires an investment that grows at least 8% per year. Then I simply check if its value has historically doubled every 9 years.
Thus, if a mutual fund had a NAVPS of P10 back in the year 2000, then the NAVPS in the year 2018 should be P40 or higher. Because it’s been 18 years and the price per share should have doubled twice already if it has an annual growth rate of 8%.
If not, then I can now move on and check other mutual funds or other investments, until I find one that can help me reach my financial goal.
Lastly, I like the Rule of 72 because it is a great tool to teach people the importance of investing. It is a simple way to show the power of compounding and make people realize how much money they’re missing out on if they don’t invest.