Double Your Money With This Simple Financial Rule
How the Rule of 72 Can Help You Build Wealth Without Much Risk
Do you want to know how to double your money? The Rule of 72 shows you how to do this without taking on too much risk in about 7 years.
What's the Rule of 72?
The Rule of 72 states that the amount of time required to double your money equals 72 divided by your rate of return. For example:
- If you invest money at a 10 percent return, you will double your money every 7.2 years. (72/10 = 7.2)
- If you invest at a 9 percent return, you will double your money every 8 years. (72/9 = 8)
- If you invest at an 8 percent return, you will double your money every 9 years. (72/8 = 9)
- If you invest at a 7 percent 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 rule works because of the wonders of compound interest.)
What Realistic Returns Can I Expect?
The 25-year average annualized return for the S&P 500 (from the time period 1987 - 2012) is 9.61 percent.
In other words, if you had invested in an index fund that tracks the S&P 500 in 1987, and you never withdrew the money, you would have average returns of 9.61 percent per year. At that rate, you'd double your money every 7.5 years.
It's important to understand that the market will take a wild swing in any given particular year. During the 25-year time period from 1987 to 2012, the market gave returns as high as 37 percent in the year 1995, and returns as low as -37 percent in 2008.
We are discussing a long-time average, and the only way to capture that 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).
What If I Only Doubled My 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 percent (rather than 9.8 percent). 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 Bottom Line: 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.