What is "The Rule of 72"?
November 17th, 2020
Have you ever wondered how long before money doubles or what the true cost of a credit card that charges 25% annually is?
I have the tool for you, and it’s called “The Rule of 72”.
The Rule of 72 is a simple way to determine how long an investment will take to double given a fixed annual rate of interest. By dividing 72 by the annual rate of return, you can obtain a rough estimate of how many years it will take for the initial item to double. With this formula you can calculate the real cost of an investment or debt.
Here is how it works:
Ex. Your credit card has a 25% actual percentage rate (APR) and you have a $1,000 charged to the card. You take 72 and divide 25%, 72/25 = 2.88. This means that in 2.88 years, the $1,000 charge would double to $2,000. Please note that you are required to make a minimum monthly payment, but the above example shows how dangerous credit card interest can be.
Try to become more aware of the costs of your debts and how they can erode your savings. Often people buy a sale item on credit and then do not consider the interest they must pay to buy the item.
Here are several more real-life examples:
- If your rent increases 8% annually, how many years before it doubles?
72/8 = 9, that means in 9 years your average $1,500 Portland area one-bedroom apartment would increase to $3,000 monthly
- The bank/credit union is offering you an annual interest rate of .25% how long before your $1,000 savings account doubles?
72/.25 = 288 years. Yes, you read that correctly, it would take 288 years for your $1,000 to double at your bank at .25% interest rate.
All these illustrations show that you should focus on how the interest rate is affecting your finances and your life. As shown above, the same institution might lend you money at 25% but only give you .25%, a 100-fold difference – remember, buyer beware!