The Rule of 72
By Jeffrey S. Watson
A new investing colleague and I were talking about the “Rule of 72”. I explained what it is and how easy it is to make the calculation when you don’t have to consider the sticky fingers of the taxing authority when investments are made in Roth accounts, for example.
The Rule of 72 is a simplified formula to calculate how long it will take for an investment to double in value: t ≈72/r, where t is the number of periods required to double an investment in value, and r is the interest rate per period as a percentage, not as a decimal. For example, if your investment is earning 12% a year, 72 ÷ 12 = 6, which means it would take approximately 6 years for your investment to double in value.
Using my financial calculator, the Rule of 72, and my ideal rate of return, I showed my investing colleague how I am able to double my money approximately every 2 years. Why? Because I structure deals so that my rate of return is somewhere around 36%. How do I do that? Well…
That high rate of return is a lofty goal, and it’s one I have to work hard to achieve by being very deliberate in my investment choices. That’s why it’s important to have mathematical metrics for testing how good your investing structure is.
In addition to the Rule of 72, another mathematical metric I use is comparing the projected or past performance of an investment against the 7-year track record of the S&P 500. I understand that there is risk associated with the S&P 500 (especially since it should really be called the “Magnificent 7 and Remaining 493”!), but a comparison of its track record to your investment performance will give you a good idea of how well your investments are doing.
Another comparison you can make is to the return on “supposedly” risk-free U.S. Treasury Bonds. That rate has dropped some recently, but for a time, they were getting around 5%. Comparing your investment returns to this number as well as to the track record of the S&P 500 (which is historically around 11%) will give you a good idea as to the effectiveness of your investments.
Using these three metrics will give you an outside opinion as to the validity of what you are doing and the likelihood of accomplishing your desired goals.
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Jeffery S. Watson is an attorney who has had an active trial and hearing practice for more than 25 years. As a contingent fee trial lawyer, he has a unique perspective on investing and wealth protection. He has tried over 20 civil jury trials and has handled thousands of contested hearings. Jeff has changed the law in Ohio four times via litigation. Read more of his viewpoints at WatsonInvested.com.
