The rule of 72 is an easy way to calculate how long it will take to double your investment. It is a mental shortcut that allow you to quickly estimate growth rate. We are concerned with growth rate of investments and debt.
Rule of 72 and debt
Rule of 72 shows how long it will take for your debt to double. Suppose your credit card debt is $1000 and the interest rate is 36%
72/36 = 2 years 72/24 = 3 years
Your credit card interest rates tend to hover between 24% to 36% so the debt will double in 2 – 3 years. This is the primary reason why your should pay off your credit card debt every month and make sure you have money to pay off the bill when you use the card to make a purchase.
Rule of 72 and investments
S&P 500 returned 8% / year on average between 1957 and 2018. What would be the doubling time for this investment.
72 / 8 = 9 years
What would the return be in 27 years for $1000. $1000 would double to $2000 in 9 years, to $4000 in 18 years, and $8000 in 27 years. Suppose we compare the S&P 500 index fund offered by Vanguard and Scotiabank.
Return = fund earning - MER Vanguard = 8% - 0.06% = 7.94% Scotiabank = 8% - 1.19% = 6.81% Vanguard doubling time = 72/7.94 = 9 years Scotiabank doubling time = 72/6.81 = 10.6 years
Note that we purchased the same fund from two source and due to a fee difference of 1.13%, the doubling time increased by 1.6 years.
Rule of 72 and Inflation
We also need to take inflation into account. Between 2000 – 2019, Canadian inflation has remained below 3%, so let assume an inflation rate of 3%. Inflation is the rate at which your money loses purchasing power. So $100 in 2000 is worth $97 in 2001.
Vanguard after inflation = 7.94 - 3 = 4.94% Scotiabank after inflation = 6.81 - 3 = 3.81% Vanguard doubling time = 72/4.94 = 14.6 years Scotiabank doubling time = 72/3.81 = 18.9 years
Note how many years inflation added to the doubling time!
A popular investment is GIC (Guaranteed Income Certificates). In 2020, they typically offer between 1-2%. Let’s calculate for 2%.
GIC after inflation = 2 - 3 = -1% GIC doubling time = 72/-1 = never
By definition, GICs offer less income than inflation so you will never double your money. Mathematically speaking, GICs do not qualify to be called an investment. Investment requires possibility of profit. With GICs, you are guaranteed to lose money. The same goes for your savings account
Lesson:
- Calculate doubling time for your debt. It will motivate you to pay off debt and tell you which debt you need to pay first.
- Calculate doubling time for investments. Don’t forget to include inflation in your calculation. It will help you avoid investments that will get help you achieve your financial goals.
