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Ask About the Rule of 72

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By | May 26, 2012

Dear Toolkit,

Can you give me a clue about "The Rule of 72?"

Thanks,

Interest Ed

Dear Ed,

The Rule of 72 goes like this. . .to find out roughly how many years it will take to double your money at a given rate of interest compounded annually, just divide the interest rate into 72.

Let's say you want a quick idea of how long it'll take to double your money if you lend your brother-in-law the money he needs to remodel your sister's kitchen, and you only charge him 9 percent interest. Divide 9 into 72 and you get 8 years as a quick estimate. (If you run the actual numbers on your calculator, you'll get 8.04 years exactly.)

Suppose he counters with an offer to pay you 6 percent? Off the top of your head you compute--6 into 72 equals 12 years--and dazzle him with your mathematical speed as you turn down the offer, saying it's too long a time to tie up your capital for that kind of return!

The Rule of 72 also works backward. Let's say you tell your brother-in-law that you really need to double your money in 6 years to make it worth your while. He says he needs to know what percent that is before he can give you an answer. So you divide 6 years into 72 and learn that you'll have to charge him around 12 percent interest. (If you run this on your calculator, you'll find it comes out to 11.9 percent precisely.) Whereupon he decides your sister can do without a new kitchen.

One caveat: This quick and dirty estimate rule works great up to the high teens, but when you get to 20 percent and up it becomes very inaccurate. So, if you're planning to do any really high finance, be sure to take your financial calculator along and forget about the Rule of 72!

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