The magic of compound interest and how the Rule of 72 can help you see how quickly you can double your money
If you were to invest €50,000, how quickly do you think you could realistically double your money?
If you have savings goals in mind and you want to have an estimate of how long it will take to grow your wealth, there is a simple rule you can follow. Read on to find out more.
The “rule of 72” can help you to work out how your investment is working for you and how quickly you are growing your wealth.
The “rule of 72” is a simple way that you can work out how quickly your savings might double in value, based on the expected rate of return.
It is also a useful tool in long term planning to see how long it takes for inflation to halve your spending power. Especially as inflation is higher at the moment, your spending power erodes faster over time, and if you don’t factor this into your longer term planning you can find yourself a long way from your target.
Let’s look at the inflation impact by using the rule of 72:
If you anticipate you need a net income of €4,000 per month for a comfortable quality of life now in 2023, and you expect inflation to average 3% per annum over the next 25 years, between now and when you plan to retire, you need to adjust your target.
The rule of 72 formula is 72 ÷ the annual inflation rate = the number of years for your spending power to half.
72 ÷ 3 = 24.
This means with inflation at 3% per annum your cost of living will double in 24 years. So that planned €4,000 per month based on today’s costs, needs to be adjusted up to €8,000 per month.
Now, let’s look at applying the rule of 72 to your investments, to track the growth.
The formula is:
Number of years = 72 ÷ rate of interest/return
So, if your money is in a fixed-interest account paying a guaranteed 2% each year, it would take 36 years for your cash to double in value.
36 years = 72 ÷ 2%
This is only an approximation but can be useful as a quick and easy way to get an idea of how your wealth will grow.
We know that most banks are offering less than 2% pa, even after interest rates have gone up unless you are locking your money away for longer periods. If you are earning only 0.5% per annum, it could take you 144 years for your cash to double in value! You probably won’t live long enough to see that happen and, even if you did, after adjusting for inflation, you would still be going backwards in terms of spending power.
The chart below shows how long it could take to double your money, or for inflation to halve your spending power, based on different rates of return.
The chart is for illustrative purposes only. The “rule of 72” is only an approximation. Figures take no account of additional savings that an investor might make or the impact of inflation.
Of course, these are only approximations, and investment returns can rarely be guaranteed. It does show, however, that being too cautious with your money could hinder your progress towards your long-term goals, and that high inflation can erode the value of your savings.
Sensible, objectives focused and appropriately diversified investing can help you towards your long-term targets.
When it comes to planning to meet long-term goals, the return you achieve on your wealth can help to determine whether you’ll have “enough” to reach them.
If you are too cautious when it comes to investing your wealth, it could well result in slower progress towards your targets.
For example, putting all your pension savings in an investment with a 2% return might be low-risk, but it will take you 36 years to double your money. If you are in your 50s or 60s, you may not have that time.
Compare this to investing in a well-diversified portfolio. If you could just achieve a little better annual return – say 5% rather than 2% – you could double your asset in just over 14 years.
According to BlackRock, European shares returned an average of 5.5% a year between 2014 and 2023. US equities returned an average of 12.6% a year during the same period.
Compare this to cash, which returned 0.8% on average.
Of course, the value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
However, in the long term, investing can provide you with the potential for higher returns. According to the “rule of 72”, that means you could double your money in less time – helping you to meet your savings goals sooner.
Get in touch
If you’d like help in building a saving and investing portfolio that’s right for you, please get in touch. Email us at info@extinvestments.com and we will be happy to speak with you.
Please note
This article is for information only. Please do not act based on anything you might read in this article.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
