Many people long to build wealth. They want the freedom of not living from paycheck to paycheck. Different voices share various methods of increasing your net worth.
The diversity of financial voices can confuse, even leading to feeling overwhelmed. A method you can apply to cut through the noise is to focus on tested and proven money principles. The rule of 72 is an example of a framework that generally works regardless of perspective.
What is the rule of 72? How does it impact your finances? Why should you consider it?
Its Origins
The rule of 72 traces its origins to more than half a century ago. A gentleman from Italy, Luca Pacioli, shares it. Centuries later, the rule still works.
When Luca Pacioli presents the formula, he does not bother explaining or elaborating it. This act makes historians think that someone else before him had discovered it. It would explain why he did not need to detail it to his listeners.
He introduced the concept in a book published in 1494. Schools in northern Italy used the book. Many consider Luca Pacioli as the father of accounting.
What Is The Rule of 72?
The rule of 72 is a formula that helps determine how long it takes for an amount to double at a given interest rate. The framework measures the investment period in years. The assumption is that the initial amount remains constant.
For example, if a financial product bears an interest rate of ten percent, it would take 7.2 years for the initial amount to double, an answer you get when you divide 72 by 10. A rate of three percent would increase the period to 24 years. An eight percent return would double the principal in 9 years.
The formula includes the money the initial interest earned will gain over time. The framework assumes a compounding effect. You can also use the structure to determine the impact in the opposite direction, for example, how fast your money will reduce to zero at a specific inflation rate.
Exceptions
Exceptions to the rule of 72 include large capital amounts. The higher the number, the more likely you will notice that the result is not exact. Consider it as a general guideline.
Higher interest rates, for example, beyond twenty percent, also do not align with this formula. It generally works for rates that fall between four and twenty percent. The variances are because the number 72 is an estimation.
A deep dive into the calculation behind the formula gives a rounded-off figure of 72.7. You can see the impact of the decimal differences much more clearly with higher capital sums. However, it is more convenient to use numbers that are easily divisible.
Building Wealth Using The Rule of 72
A critical skill for building wealth is comparing financial products objectively. The rule of 72 helps you do this easily. Use it to compare investment offerings.
Shorten your journey to wealth by choosing the product that gives the highest return for your investment. Remember, money is finite. Opportunity cost, therefore, comes into play.
Practice using the rule of 72 when making investment decisions. Some online calculators account for related scenarios, for example, additional deposits to the seed capital, to give a better picture of the total amount to expect after an investment period. The formula simplifies for you the impact of compound interest.
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