Estimating returns on your investment
Like everything in life, investments come with risk. But do they really have too?
Some are minimal while others are significant. Risk is not necessarily a bad thing. In fact higher risk betters your odds of receiving a nice return on your money. Of course the opposite is true if the factors which impact an investment do not perform well. Knowing the amount of risk associated with each investment type is important. Equally as important is also understanding the potential long-term rate of return.
Fortunately, there's an easy way to quickly determine potential rate of return on an investment known as the Rule of 72.
The Rule of 72
What's really nice about the Rule of 72 is anyone can do it! You don't need a master's degree from an accredited college or expensive technology to forecast your potential rate of return. The Rule of 72 will provide you with the estimated number of years required to double money at a fixed interest rate.
Simply grab a piece of paper, a pen or a calculator and divide the fixed interest rate into 72. The number you come up with will be the approximate number of years it will take you to double your money. For example, if you want to know how long it will take to double your money at 12% interest, divide 12 into 72 and you get six years. Therefore it will take you six years to earn 12% on your investment.
Extending out the Rule of 72 can also show you the length of time it would take you to triple or even quadruple your rate of return. For example, to see how long it would take to triple your money, add 36 to 72 which equals 108. then divide the fixed interest rate into 108. To determine how many years it will take to quadruple your money, follow the same formula but add 72 and 72 which equals 144.
The Rule of 72 also takes into account the amount of compound interest earned during a certain time period. Compound interest is interest earned on interest.
- 1st year you make $10,000 at 5% interest which equals $10,500.
- 2nd year the $10,500 you have will also be calculated at 5% interest. Therefore the $500 you made the previous year is added to the original balance and calculated as $10,500 instead of just the original principal of $10,000.
Better decisions and estimates on reaching our financial goals
Using the Rule of 72 is smart way to determine which investment option will best serve your financial goals and provide an approximate timetable to doubling, tripling or even possibly quadrupling your investment.