Let me give you two examples of
how the Rule of 72 may be used.

First, in mentally calculating
how long it takes to double the value of a
portfolio. Second, in figuring out how long it
takes inflation to halve the purchasing power of
money.

**IN DOUBLING
THE VALUE OF A PORTFOLIO**

If you have a well-diversified
savings and investment portfolio that gives you
a steady 6% growth rate each year, then on the
surface, it would appear that to double the
value of your portfolio, which means generating
a total simple return over time of 100%, you
would require 100 divided by 6 years, or about
17 years to do so. But actually it takes less
time because of the growth boost provided by
compound interest, which impressed Albert
Einstein so much he declared it the 8th Wonder
of the World! The snowballing growth of a
compounding portfolio means you can reach this
target faster than is generally expected based
on mere linear mathematics (such as straight
addition).

Before I show you how the Rule of
72 might be used to quickly generate the correct
answer to a compound interest calculation, let's
do things the long, slow way...

If you begin with $1,000, after
one year you will have $1,060. If we then
multiply 1.06 to that new base sum of $1,060, we
see that after two years you'll have $1,124.

As we continue with this sequence
all the way to the point at which an approximate
doubling of value from the original $1,000 to
$2,000 has been reached, you are welcome to
follow along with your calculator to double
check my numbers. To keep the presentation
clearer, I'll take the liberty of rounding off
the decimal places to the nearest integer:

After three years, you'll have
$1,191. Let me now show you the amounts after
four, five, six and so on up to twelve years:
$1,262, $1,338, $1,419, $1,504, $1,594, $1,689,
$1,791, $1,898 and $2,012.

Doing things through arduous
calculation shows us that it takes us about 12
years to double the value of our initial
investment from $1,000 to $2,000, if we enjoy a
steady 6% annual growth rate. Note that if we
take this seemingly magical number of 72 and
divide it by the raw number representing the
interest rate, in this case 6, that 72 divided
by 6 = 12!

What's astounding is that this
isn't a rare coincidence. Regardless of what
normal interest rate we might use, say in the
range of 1% through to 20%, division of the
number 72 by the raw interest rate gives us a
good indication of how many years it takes to
double value. So, for instance, if you have a
savings account that grows your money at 2%
year, you may use the Rule of 72 to quickly
figure out that 72 divided by 2 = 36 years is
required to double your money, while an
investment portfolio growing at a compounded
annualised growth rate of 7.2% would double in
value over 10 years.

**IN HALVING THE
PURCHASING POWER OF MONEY THROUGH INFLATION**

Pretty much the same thing
applies if we want to get a handle on how long
it would take for a particular inflation rate to
halve the value of your money's purchasing
power. For instance, if we have a steady
inflation rate of 4%, what this means is that if
something you wish to buy is $1,000 today, it will
cost $1,040 next year. I won't bore you with the
complete sequence of compounding costs, but if
you take the time to run the numbers yourself,
you'll find that after 18 years, the cost of
that particular item would be $2,026, which is
pretty close to $2,000.

A 4% inflation rate will double
the cost of items in 18 years.

Once again, we find that if we
whip out that magic number 72 and divide it by
the raw inflation rate, this time 4, we end up
with 72 divided by 4 = 18! I think that's really
cool.

Another way of looking at
inflation is to consider how quickly the
purchasing power of money erodes. If by the Rule
of 72, it takes 18 years for a 4% annual
inflation rate to double the cost of goods and
services, then it is just as accurate to say
that by the Rule of 72, it takes 18 years for a
4% inflation rate to HALVE the purchasing power
of your cash.

If you're mathematically
inclined, you will have quickly grasped the
structure and importance of the Rule of 72. But
if you aren't keen on numbers, I've probably
given you a headache by now. So, either way,
I'll stop soon.

In closing, do understand that
the key reason to invest wisely for higher
long-term returns than you're likely to gain
from pure savings instruments like bank deposits
is to keep pace with inflation or, better yet,
race ahead of it. If you would like to learn
more about the importance of investing, you may
read my article entitled **
What is Investing**?
And if you are based in Malaysia, and reckon you
might want my help in the realm of financial
planning and retirement planning, you may learn
more about me **
here**.

**
© Rajen Devadason**