Well, through this blog I would like convey a very important rule in finance which investors take into account while calculating financial growth & the years it would take to get the investment amount doubled i.e. the rule of 72. It is a very simple rule which states that whatever is the rate of interest one gets on his investment should divide 72 & the answer that comes is the no. of years that will be taken to double that investment amount.
It simply implies
72/rate of annual interest = no. of years for amt. to get doubled
If you get 8% on your investment of Rs 100000 then 72/8=9 years i.e. it would take 9 years to get your one lac to 2 lacs. It is a simple rule but it is applicable only when there is interest being compounded annually. The rule could also be used to calculate time value of money. For time value of money inflation is its biggest determinant. The higher the inflation quickly the value of money will get perished. Using the rule of 72 we can also calculate the no. of years it would take to get the worth of money halved. E.g. if inflation is 6% then 72/6=12 years. Hence it would take 12 years for the actual worth of a particular amt. to get halved.
Suitable to calculate financial growth as well
As we discussed previously about the concept of financial growth. This rule also has the explanation for the actual net worth to get doubled. As discussed previously it is not about the rate of interest that one fetches, it is the real rate of interest that matters i.e. rate of interest – rate of inflation. So with this we’ll have the real rate of interest which again we’ll divide 72 from it & the answer would tell us about the no. of years for our actual net worth/purchasing power to get doubled. E.g. if we are getting 14% interest & inflation is 8%, then real return =14-8=6% i.e. 72/6=12 years it would take for the invested amount’s actual net worth to get doubled. It simply means that if a man has Rs1000000 for his daughter’s marriage which is supposed to be after 12 years then with the above explanation after 12 years he’ll have Rs 200000 worth of today’s date & he could thus marry his 2 daughters. It means that he has gone through 100% growth or a growth of 1 extra marriage in 12 years.
Adjusting For Higher Rates
The rule of 72 is reasonably accurate for interest rates between 6% and 10%. When dealing with rates outside this range, the rule can be adjusted by adding or subtracting 1 from 72 for every 3 points the interest rate diverges from 8%. So for 11% annual compounding interest, the rule of 73 is more appropriate; for 14%, it would be the rule of 74; for 5%, the rule of 71.
For example, say you have a 22% rate of return (congratulations). The rule of 72 says the initial investment will double in 3.27 years. Since 22 – 8 is 14, and 14 ÷ 3 is 4.67 ≈ 5, the adjusted rule would use 72 + 5 = 77 for the numerator. This gives a return of 3.5, meaning you’ll have to wait another quarter to double your money.
Conclusion
As we have now gone through rule now it seems & it is a very simple rule to apply also. Very easy to understand & anyone who is not so good into calculations & analysis can also use/apply this rule to know the time to get his amount to get doubled. It is error-free to a very good extent, easy to understand & simple to use for anyone.
Written By:
Kshitij Kumar
Finnacle 