Double Your Money With This Simple Financial Rule
The rule of 72 can help you build wealth without much risk
If you want to double your money, the rule of 72 shows you how to do so in about seven years without taking on too much risk. The rule states that the amount of time required to double your money can be estimated by dividing 72 by your rate of return. For example:
- If you invest money at a 10% return, you will double your money every 7.2 years. (72/10 = 7.2)
- If you invest at a 9% return, you will double your money every 8 years. (72/9 = 8)
- If you invest at an 8% return, you will double your money every 9 years. (72/8 = 9)
- If you invest at a 7% return, you will double your money every 10.2 years. (72/7 = 10.2)
The rule of 72 assumes that you reinvest your dividends and capital gains. This works because of the wonders of compound interest.
The 25-year average annualized return for the S&P 500 from 1994 through 2018 was 8.52%. In other words, if you had invested in an index fund that tracks the S&P 500 in 1994 and you never withdrew the money, you would have average returns of 8.52% per year. At that rate, you should expect to double your money about every 8.45 years.
It's important to understand that the market often takes wild swings in any given particular year and does not simply grow at the average rate. During the 25 years from 1994 through 2018, the market gave returns as high as 34% in 1995 but declined by as much as 38% in 2008.
The only way to capture a long-time average is to stay on course through thick and thin. Many investors get tempted to buy more when stocks are climbing, or get spooked and sell their holdings during a decline.
Investing according to your emotions isn't a good strategy. Even though it's difficult, you'll benefit more from staying in the market when times get rough—unless you're very close to retirement.
Doubling Money Every Decade
If historical data provides any clue, it's reasonable to expect that a person can double their money every 7.5 years, according to the rule of 72.
However, investing legend Warren Buffet predicts that the long-term returns of the U.S. stock market in the 21st century will be lower than what we experienced in the 20th century. He says to expect long-term annualized returns at 7%, rather than 9.8%. Based on that assumption, the Rule of 72 says it'll take you 10 years to double your money.
That's not bad. Imagine that you invest $5,000 at age 20. By age 30, you will have $10,000. At 40, you'll have $20,000. At 50, that becomes $40,000.
By age 60, when you're nearing retirement, you'll have grown your initial $5,000 investment into $80,000.
The rule of 72 teaches you how to double your money, but it's up to you to take action. Invest in the broad market, stay patient through volatile upward and downward swings, and reinvest your gains.