The Rule of 72 is a long-standing way to determine how long an investment will take to double given a fixed annual rate of interest. You simply divide 72 by the annual rate of return to determine the number of years it will take to double the investment. For example, 72 / 8% annual return results in an expected nine years to double. What many investors don’t realize is that the Rule of 72 isn’t exactly factual science. The Rule of 72 is less precise as the rates of return increase. Many investors prefer the Rule of 69.3 for maximum accuracy.
More importantly, many investors overlook two important aspects of the Rule of 72. First, to attain the double you must achieve the rate of return EVERY year – not just an average per year. Those investing in the stock market expecting an average annual return of 8% will be disappointed when their investment doesn’t double in nine years. Any years less than the 8% expected will delay the compound – especially if a year is negative.
Further, investors who take distributions from their investment account should not consider the Rule of 72. The rule is a measurement of continuous compounding and if you are taking principal or the earnings from the account, there is no compounding to occur.
When planning for retirement, it’s prudent to set proper expectations so you increase your chance of success. Applying something like the Rule of 72 without properly understanding the concept can lead to disappointment or bad decisions that negatively affect your retirement.