What is the Rule of 72 in Finance? - Definition & Formula

Instructor: Michael Cozad

Michael is a financial planner and has a master's degree in financial services.

This lesson will define the 'Rule of 72', a financial term as well as a formula. Also, this lesson will explain the formula and how the phrase can be used practically in everyday financial situations.

Definition

The Rule of 72 in finance is a phrase (and a formula) that, when solved, calculates the approximate number of periods (typically years) in which you can double your money at a certain interest rate. Should the formula include the number of years in which you desire to double your money, the interest rate needed to double the money can be identified.

It should be noted that the formula gives an approximation of the number of years needed or the interest rate needed to double the money, and is not exact. Further, interest rates are very rarely guaranteed, so it is important to keep this in mind when attempting to plan or project using this formula.

Formula

With this formula, provided you have all but one variable, you can solve the equation for the missing variable.

N = 72 / r

Where:

N = number of periods, usually years

72 = constant

r = interest rate

Examples

Let's start with a relatively simple example. Assuming an investment will earn 8% per year, the formula can be solved as follows to determine the number of years it will take for the investment, growing at 8% per year, to double.

In this instance, 8 is the interest rate, so we will plug it in for r.

N = 72 / 8

N = 9

Thus, the investment will double in approximately 9 years.

Rearranging the formula to solve for the approximate number of years in which the investment will double can be done as follows:

9 = 72 / r

r = 72 / 9

r = 8, or 8%

Thus, the investment needs to grow at 8% per year to double in approximately 9 years.

Other Applications

Other applications of this formula can include determining in how many years a price of a given item may double (using an inflation rate instead of an interest rate) or solving for the inflation rate using the number of years which you think the cost of an item may double.

Assuming inflation will be 3.00% and that a car costs $20,000, in how many years will the cost of the car double?

N = 72 / 3

N = 24

Thus, in approximately 24 years the cost of the car will double to $40,000. Note that in the formula, the current price of the item is irrelevant to solving the equation.

Now, assume the inflation rate is unknown, but it is believed that the cost of the car will double in approximately 24 years. What is the rate of inflation?

24 = 72 / r

r = 72 / 24

r = 3, or 3%

Thus, the rate of inflation for the car is 3%.

Lesson Summary

The Rule of 72 in finance is a phrase as well as a formula that can help you to calculate the number of periods at which your investment can double.

The formula for the rule is:

N = 72 / r

Where:

N = number of periods, usually years

72 = constant

r = interest rate

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