“The most powerful force in universe is compound interest” – Albert Einstein
The concept of compounding is well known across the investment community and the two most important determinants of wealth over the long term are ‘Time’ and ‘Return’. While it is a known fact that wealth is usually created by holding onto your investments over the long term, many investors, because of their emotions like greed, chase the latter. History and experience tell us that the time or investment horizon is as important as returns for creating wealth over the long term or achieving a goal.
Like each individual goes through a different path in their life, they tend to have different objectives or goals as investors. Some individuals may have a goal to buy a house after 5 years, some may want to save for their children’s education, while some may want to plan for their retirement. Different asset classes are influenced by different factors. Investors too, set different expectations from various asset classes. Equities for example, are known to have potential for wealth creation over the long term, while debt could be used to provide stability to the portfolio or could be used to create corpus for emergencies. On the other hand, gold protects you against inflation and also acts as a hedge during uncertainties.
Given the nature of investors’ goals and different risk return profiles of different asset classes, how does one connect the dots in terms of time and returns?
One of the methods or ways investors can link return and time is through Rule of 72. The Rule of 72 is a mental math shortcut or a thumb rule that tells you approximately how many years it will take for your money to double at a given rate or return. Here’s the formula:
Years to double = 72 /Interest Rate or Return on an asset
Rule of 72 and Investments
For example, if an asset is compounding 6% annually, it will take approximately 12 years (72/6%) for that asset to double in value. Likewise, if an investor wants to double his/her money in 10 years, the return expectation should be approximately 7.2% (72/10 years). Below table shows number of years it takes for an investment to double at various return points.
| Rate of Return | Number of years to Double | Rate of Return | Number of years to Double |
| 1% | 72 | 8% | 9 |
| 2% | 36 | 9% | 8 |
| 3% | 24 | 10% | 7.2 |
| 4% | 18 | 11% | 6.55 |
| 5% | 14.4 | 12% | 6 |
| 6% | 12 | 13% | 5.54 |
| 7% | 10.29 | 14% | 5.14 |
Rule of 72 and Expenses
If the rate of return is 4%, it will take 18 years for the investment to double. Similarly, if the rate of return is say 11% it will take 6.55 years for the investment to double. Thus, based on return expectation and Rule of 72, investor can choose the right asset class.
As investors are concerned with the real returns, one can also use the rule of 72 for inflation or expenses like healthcare cost. If medical expenses increase at 8% per year (which is faster than retail inflation), medical costs will double in 72/8 or about 9 years.
Rule of 72 and Goals
Investors can use this rule while planning for their finances or for setting up a goal. Consider an individual who wants to buy a car worth Rs 8 lacs after 6 years and the returns expectation from an asset class is 12%. What should be the investment amount today? Based on this rule, investor should invest Rs 4 lacs in an asset with return expectation of 12%, so that his goal of buying a car can be achieved after 6 years.
The Rule of 72 is a practical eye opener that forces you to ask shrewd questions before making important investment or personal finance decisions. It gives investors a perspective on which asset class to choose depending upon their goals and time horizon. Historically, equities have delivered higher returns and hence, have helped in doubling investments faster than other asset classes. Therefore, a key lesson is not to avoid equities. This Rule, once again reiterates the fact that the early one starts investing in life, the better it would be for them. Patience and Discipline are, therefore the key for growing wealth over the long term.
