What is the rule of 72? Important concept to know on your path to FIRE (financial independence retire early)
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| Reading stock ticker symbols! |
My wife and I are recent early retirees at ages 51 and 48. We’ve been retired since August 2020, and we’ve been slow traveling with our traveling companion Toby, a 13 pound Pomeranian dog. We are followers of the FIRE (financial independence retire early) movement, which is in its simplicity, requires lowering your expenses and maximizing savings for early retirement.
In this post, I’d like to discuss the important concept of the ‘rule of 72.’
What is the rule of 72?
The rule of 72 is a method of calculating how quickly an amount doubles. This is the actual formula:
t = 72 / r
*where t is how many years it takes to double the money, and r is the rate of return
Rate of return always changes every year. But over a long period of time, like a 10 year timeframe, you can reasonably expect about 10% rate of return, if you invested in a S&P500 index fund.
One of the worst decades in our recent memory for S&P 500 was from January 2000 to December 2009. In that decade, you would’ve lost money as the index returned -.95%.
One of the best decades in recent memory was from 2010 to November 2019 when it returned 370%!
The important thing to remember is that if you average out all the years (positive rate of return or negative rate of return), you would still end up around 10%. This is the significance of investing your money in the stock market and not in a savings account or CD.
To calculate how quickly your money doubles, simply substitute ‘r’ for rate of return. Divide that from 72 to get the number.
Here’s an example: if the rate of return is 8%, then divide 72 by 8, which equals 9 years. It takes 9 years to double your money.
Another words, if you already have $100,000 invested in your retirement account, then under this scenario, you can double your $100,000 to $200,000 in 9 years.
If your rate of return is 10% (you invested in S&P 500 index fund), then it would take 7.2 years to double your money. (72 divided by 10 = 7.2)
In conclusion:
Rule of 72 is used to quickly figure out how fast your money will double. Because you’re taking a guess at what the rate of return will be, this is not going to tell you how your money will actually do in the future. Your rate of return may be better than that or worse than that.
It does however, give you an idea when you can expect your money to double based on past performance. That past performance equals a reasonable estimate for the stock market returning about 10%, if you bought exclusively S&P500 index fund, for example.
Looking at these numbers regularly will encourage you to keep pushing forth to reach your goal to retire early. I know it helped me!
I certainly hope you can get closer to your goal to reach financial independence and to retire early. Thank you all for reading!
Jake
Wandering Money Pig
Please check out our YouTube channel ‘Wandering Money Pig’ showcasing our travels and our Pomeranian dog! https://www.youtube.com/channel/UC3kl9f4W9sfNG5h1l-x6nHw
