The Rule of 72 is a formula that is used to estimate how many years it will take for you to double your money given a an averge yearly growth rate.
Would you like to double your money every "x" years?
The Rule of 72 is not exact, to get an exact figure would require you to engage in a complex mathematical formula. But it is not necessary to do so.
Heck, the growth rate you use will hardly be accurate to the nearest decimal point. It may be 8% growth it may be 8.2%.
The rule is only an estimate.
Here's a short example of the Rule of 72 in action.
Suppose you could achieve an annual rate of return of, say, 8% then a rough calculation of how many years it would take for you to double your pot would be: 72/8 = 9 years.
Whoa! We here you cry. That doesn't sound too good.
Well, actually, if you think about it, that means an average of 8% rate of return every year for 9 years. You can bet that some of those years you would have beaten the Indices. And some you may have lagged behind a little.
Fact is, what do the professionals achieve? They may return 15% one year but -5% another. Or any other ombination.
Are Warren Buffett, Charlie Munger, Walter Schloss and whole load of other legends beginning to make sense? Some of these guys achieved 20%+ average rates of return year in, year out.
Walter Schloss managed it for over 4 decades.
Now, we private investors can't match that. But can we beat the rate of 8%?
We'd like to think so.
Let's do another what if? Suppose your average rate of return was 10% a quick mental calculation would tell you that it would take 7.2 years for you to double your Pension Pot.
What if you could average 12% (which would be very good by the way) then your pot would double in 6 years. That sounds reasonable.
To double your money in 5 years, would ask you to achieve an annual rate of return of nearly 15%. Achievable, but ambitious.
So select your target and go for it.
Governments around the world use the Rule of 72 for a lot of economic quantities.
It is a formula that can be applied to a lot of things - population, Gross Domestic Product, loans, etc.
If, for example the Gross Domestic Product (GDP) of the UK were to grow at, say, 5% anually, then the economy would be expected to double in 72/5 = 14.4 years
What about inflation? If the rate of inflation is 3% then the purchasing power of money will be halved in 72/3 = 24 years.
And then, just as it is all sounding simple, along come the mathematicians to complicate matters. The Rule of 72 is only an estimate. The precise formula is complex.
And the mathematicians complicate it even further by adding in modifications.
We like simple. And 72/6 is simple. After all, it's only a guide. Albeit, a very useful one.
The use of the Rule of 72 is a rough guide.
Use it for what it is. An estimate of how your portfolio is performing.
It can also serve as a target for your Pension Pot.
Everybody likes the idea of doubling their money. That's just human nature.
Depending on your age of course, but let's say you could double your money every 10 years. How would that make you feel?
Now that's something to aim for an maybe improve on.