The Rule of 70 and the Rule of 72 are two popular shortcuts that can help investors quickly estimate the doubling time of an investment. These rules are particularly useful for grasping the potential growth of savings without diving into complex calculations. Both shortcuts serve a similar purpose, but they differ slightly in their application and accuracy. A financial advisor can help you determine how much your investment can grow over time.
What Is the Rule of 70?
The Rule of 70 is a mathematical formula used to estimate the time it takes for an investment or any quantity to double, given a fixed annual growth rate. This rule is used by investors and financial planners who want to quickly gauge the potential growth of their investments over time.
By dividing the number 70 by the annual growth rate percentage, you can determine the approximate number of years it will take for the initial amount to double. For example, if the interest rate is 7%, doubling will take 70 divided by 7 or 10 years. This quick and simple calculation provides a snapshot of the impact of compounding interest.
The Rule of 70 is a useful tool but it has limitations. For one, the rule assumes a constant growth rate, which is rarely seen in real-world scenarios. Economic conditions, market volatility and unforeseen events can all affect growth rates and make the actual doubling time longer or shorter than the rule predicts.
Additionally, the Rule of 70 does not account for factors such as inflation, taxes or fees, which can significantly affect the net growth of an investment. Therefore, it should be used in conjunction with other financial analysis tools.
What Is the Rule of 72?
The Rule of 72 is another way to estimate the time it will take for an investment to double in value, given a fixed annual rate of return. This rule produces useful insight without the need to delve into complex mathematical formulas.
By dividing 72 by the annual interest rate, investors can approximate the number of years required for their investment to grow twofold. For example, if you have an investment with an annual return rate of 6%, dividing 72 by 6 gives you 12 years for the investment to double.
The Rule of 72 also has limitations. Like the Rule of 70, it assumes a constant rate of return. Additionally, it is most accurate for interest rates between 6% and 10%. Outside this range, the approximation becomes less precise. The Rule of 72 can serve as a starting point, but is best complemented with more detailed financial analysis and advice from a financial advisor.
Major Differences of the Rule of 70 and 72
These rules are similar, but also have distinct differences that can impact their accuracy and application.
- Calculation basis: The Rule of 70 is often used for lower growth rates, typically under 10%, and is particularly useful in economic contexts like GDP growth. The Rule of 72 is more versatile and can be applied to a wider range of growth rates, making it a favorite among financial analysts for quick calculations.
- Accuracy: The Rule of 72 is generally more accurate than the Rule of 70 for growth rates that are multiples of three, such as 6% or 9%. This is because 72 is divisible by more numbers, allowing for a closer approximation in these scenarios. The Rule of 70 tends to be slightly less accurate for higher growth rates while still providing a reasonable estimate for lower rates, especially in economic growth calculations.
- Historical context: The Rule of 72 dates back to the 15th-Century mathematician Luca Pacioli. Its historical roots make it a well-established tool for financial calculations. The Rule of 70 is a more modern adaptation, often used in academic and economic studies.
- Application: The Rule of 72 is widely used in finance for calculating interest rates, investment growth, and inflation impacts. The Rule of 70 is primarily used in economic contexts, such as estimating population growth or GDP doubling time, where growth rates are typically lower.
While both the Rule of 70 and the Rule of 72 serve as valuable tools for estimating doubling time, differences in calculation basis, accuracy, historical context and application can make one more suitable than another for different scenarios. Understanding these distinctions can help you choose the right rule for your specific financial or economic analysis needs.
How to Know When to Use Each Rule
The Rule of 70 is most effective when dealing with lower growth rates, typically under 10%. It is particularly useful for long-term investments with modest growth rates, such as retirement savings or bonds.
The Rule of 72 is better suited for higher growth rates, typically above 10%. It is especially beneficial for evaluating investments with higher volatility, such as stocks or mutual funds, where returns can be more substantial.
Bottom Line
Understanding the difference between the Rule of 70 and the Rule of 72 can enhance your ability to plan your finances and devise investment strategies. Both rules serve as shortcuts to quickly and easily estimate the time it takes for an investment to double, given a fixed annual rate of return. The Rule of 70 divides 70 by the annual growth rate, while the Rule of 72 uses 72. The Rule of 72 is often preferred for its simplicity and slightly higher accuracy with common interest rates, especially those around 8%.
Investment Planning Tips
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