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The rule of 72: Should you use it?

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Spotting a good investment can be tricky. After all, the ideal investment for others may not be the best investment for you. It all comes down to a mix of data sets, personal interests and time horizons.

There's a straightforward formula—the rule of 72—that helps make sense of it all. You can use this formula to quickly compare an investment's return, helping you make savvier decisions that fit with your financial strategy.

What is the rule of 72?

The rule of 72 roughly calculates how fast an investment will double, providing a shortcut to the longhand way of computing compound interest. If you divide 72 by an investment's annual fixed rate of return, the answer is how many years it'll take the balance to double in value. However, it's not perfectly accurate because compound interest is a complex equation. The rule of 72 works best for the 6%-10% interest rate range, and is best used for back-of-the-napkin math.

For newer investors, this rule lets you easily assess the potential growth of an asset over time. It also can help seasoned investors decide if an asset is worth adding to the bunch.

How does the rule of 72 work?

The general rule of 72 formula looks like this:

72 ÷ annual rate of return = estimated number years until investment doubles. Suppose an asset has an annual rate of return of 9%. The rule of 72 suggests it would take approximately eight years to double in value (72÷9=8). So, if you were to invest $50,000 in a mutual fund earning a fixed interest rate of 9%, you could expect it to grow to around $100,000 in about eight years.

You also can use a variation of the rule of 72 formula to loosely determine the needed rate of return to see an investment double in a specific timeframe. That variation would look like this:

72 ÷ number of years in which you want the investment to double = targeted annual rate of return. For instance, if you know you want your money to double in 6 years, the rule of 72 would have you looking for an investment with an annual rate of return of around 12% (72÷6=12).

How do investors use the rule of 72?

With the rule of 72, you easily can swap in different numbers to see how investments stack up against your short- and long-term financial goals.

For instance, if the estimated doubling time seems too long for your time horizon, you might seek a different investment with a higher rate of return instead. If the doubling time is too short, you might explore ways to preserve capital or diversify your portfolio to maintain more consistent, long-term growth. Ideally, the maturity date of certain investments can match when you'll need liquid funds—like if you're budgeting for a car or house. This timing could let you leverage capital growth while staying debt-free.

The rule also can help you decide when it's time to rebalance your portfolio and explore better-performing investment options. The formula can let you compare different investments based on your risk tolerance and timeframe.

What are the benefits & drawbacks of the rule of 72?

The formula's simplicity allows you to make approximate projections without having to do complicated compound interest math. It's a tool that can help everyday people choose where to put your hard-earned dollars to achieve goals like higher education and retirement.

However, the rule's simplicity is also its greatest drawback. The formula's accuracy is largely limited to about an 8% interest rate and it doesn't account for inflation, fees, taxes or other costs that might eat away at your investment dollars. It becomes less precise the further you get from 8%. Experts suggest the rule of 69.3 lets you more accurately calculate a wider range of interest rates, but it's not used often among everyday investors because the number is harder to remember and divide. Plus, it can't be applied to anything with a fluctuating rate of return, such as stocks.

Should you use the rule of 72?

The rule of 72 could help you decide if certain investments make sense for your goals. The results could indicate when it's time to ditch an investment or put more into a particularly profitable asset.

However, it's not the perfect substitute for research or a holistic view of an investment's costs and tax implications. For that, you can tap into the expertise of a Thrivent financial advisor, who can guide you in developing a financial strategy centered on your individual goals.

Hypothetical examples are for illustrative purposes. May not be representative of actual results.