The Rule of 72 can be used for a quick basic calculation to determine if an investment is right for you based on how long it takes to double your money. Simply divide 72 by the anticipated percentage rate of return per cycle of the investment to obtain the approximate number of cycles it will take for your principal investment to double in value. The Rule of 72 provides an estimate for the investment that increases in value based on growth that is compounded per interest cycle.
As an example, consider an investment opportunity where you placed $10,000 as an initial investment and expected to earn an interest rate of 8% annually, you would apply the Rule of 72 and expect your investment to double in 72/8 = 9 years. While this is an approximation, it is not exact but fairly close to the actual time. Let’s check our answer based on a general compounding interest formula. Pf = Pi(1 + R)n, Pf is the final investment amount, Pi is the initial principal amount, R is the interest rate of return in decimal form, and n is the number of compounding cycles, in this example in terms of years. In this case, we know that the final investment amount, Pf should be equal to $20,000 (or at least very close) for the rule to hold true. So we have, Pf = $10,000(1 +0.08)9 = $19,990.04, pretty good and only $10 off of the target of $20,000. The Rule of 72 is a valuable resource you can easily use for evaluating potential investments and determining which offer the best rate of return. The Rule of 72 works well as a preliminary evaluation tool for investments that should be followed up by a more in depth investment analysis to determine if an investment is right for you based on your goals.
The Rule of 69, which is used just like the Rule of 72 is another method for determining an investments doubling time but more suited for modeling smaller compounding cycles such as daily or weekly. If we apply the Rule of 69 to the above situation with the same annual compounding, we obtain 69/8 = 8.63 years. By applying the compound interest formula, we see that Pf = $10,000(1 +0.08)8.63 = $19,428.85, which although a little further off is still a good approximation, but again more suited for a continuous compounding situation.
The author of this article, BAfriend, does not permit the copying or republishing of this content to any other website. This article is published only on www.infobarrel.com and if it appears elsewhere it has been copied without the author’s permission. Linking to this article is welcome and appreciated but no copying.
How To Calculate Compound Interest; Author: BAfriend, From InfoBarrel
Retrieved From: http://www.infobarrel.com/How_To_Calculate_Compound_Interest
Rule of 72, From Wikipedia, the free encyclopedia
Retrieved From: http://en.wikipedia.org/wiki/Rule_of_72