The finance industry is loaded with equations and formulas. You name a term and it has multiple acronyms associated with it which may be confusing for once, but it very helpful for people who wish to spend time in figuring out the right formula for estimating their financial calculations.
One such formula is the rule of 72. This rule tells you about the time frame within which your money will double itself. The formula works on the estimated rate of return as the only input you need to estimate the returns. The number you get post dividing 72 by the number will give you the number of years in which your money will double.
Let us say you have Rs. 10,000 which you have invested in an asset giving returns at the rate of 6% per annum. These Rs. 10,000 of yours are going to be Rs. 20,000 in a span of (72/6= 12) years. Hence, you have an idea when your money is going to double itself. This rule of 72 is extremely helpful when it comes to planning your retirement or any particular funds you are planning to save.
Here is a list of applications for Rule of 72
To compare investments
The rule of 72 is very useful when it comes to comparing different types of investment avenues. It will give us a fair idea regarding when our money is going to get double if we invest in that particular asset.
Let us compare Mutual funds, FD and savings account;
As on today, the rate of return of Mutual Funds is 12%, Fixed deposit is 8% and that of savings account is 4% all on upper ends. The amount to be deposited is Rs. 10,000.
Rs. 10,000 will become Rs. 20,000 in
A) In case of Mutual Funds: 72/12 = 6 years
B) In case of Fixed Deposit: 72/8 = 9 years
C) In case of Savings Account: 72/ 4 = 18 years
It is quite evident that Mutual funds will double your money fastest followed by Fixed deposit and the savings account.
You make this comparison in case of different mutual finds having different rates of return. Mutual funds are better for rewarding investment avenues. Yes, there is a lot more volatility in case of mutual funds but the returns are quite high given the span of time. But this is not a real-life situation. Inflation and other depreciating factors are not taken into consideration while making these calculations. This is the ideal situation which does not actually happen.
Now how do we insert the component of inflation? Rule of 72 works both ways.
It can give you a fair estimate of the inflation effect on the money as well.
Calculate the impact of inflation
The rule of 72 works both ways. It helps you calculate the period in which your money is going to get doubled at a given rate of interest. Same ways, for a given amount of money the period in which the money will become half of its value can also be calculated.
Let us say, you have Rs. 10,000 and assume 2% of inflation is there then it will take 36 years for your money to depreciate to half of its value. It is calculated with the same formula 72 / 2 = 36.
In case, there is a high inflation scenario with a rate of inflation of 6%, then it will take 72 / 6 = 12 years for money to become half.
In case you are looking at different investment instruments and avenues with different rate of interest. This rule is a good option to eliminate funds based on the time they will take to double your money.
Picture credits: Primerica