The rule of 72 is a simple concept to determine the period in which the investment amount will double, given the annual rate of return. Divide 72 by rate of return to know the period in which the amount will double. This is true in case the interest (fixed rate of return) is compounded.
Example: If rate of return is 12% p. a., then the money will double in (72/12) 6 years. With 10% interest rate, it will take (72/10) 7.2 years to double the money.
In case of 12% interest rate, with investment of 100 rupees
The interest for year 1 is: 100*(1+0.12) = P*(1+R) = 112 rupees
year 2 is: 112*(1+0.12) = P*(1+R)*(1*R) = 125.44
year 6 is: 100*(1*0.12) *(1*0.12) *(1*0.12) *(1*0.12) *(1*0.12) *(1*0.12) = 197.38
Thus, compounded amount at the end of ‘n’ years is: P * (1+R) ^n
P = Principal
R = Rate of Interest
The period calculated is more accurate between 5% to 10% p. a. rate of return.
Basic premises for the rule of 72:
- Interest is compounded annually
- Asset carries fixed rate of return
- Re-investment possible in similar asset
The rule of 72 applies only on case rate of return id fixed. Hence, this rule doesn’t apply to equity investment.