Wednesday, October 3, 2012

The Rule of 72 to Calculate Return on Investment

The Rule of 72 is an estimate of how long it take to double an investment given the annual rate of return. It gives the approximate number of years it will take to double your investment, and can be quite useful sometimes to get a rough idea of an investment as you don't carry your calculator everywhere, the time of value of money is an important financial concept that everyone should master, especially those taking the CFA Chartered Financial Analyst.

Example:

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You have invested $100 into a 10% fixed annual rate investment
72/10= 7.2 years, It will take your investment 7.2 years to become $200.
If we look at the normal way to calculate it we would get 100*(1.1^7.3)=$200
The exact number of years to double is 7.3 which is pretty close to our estimate.

The Rule of 72 is very accurate when we have low rate of return, but when it comes to high returns, the difference between the rule of 7.2 and the normal calculation become wider.

Here is a table showing the time it takes to double an investment with both the rule of 72 and normal calculation, you can notice that the high rates of return give a wider gap between the rule of 72 and the actual number of years.
Rule of 72 and how long it takes to double your investment given a fixed annual rate, understand the time value of money

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