The Rule of 72
How Long Does it Take for your Money to Double?
If I had a penny for every time someone asked me how long it would take their money to double, I’d have…well…a lot of pennies. It’s an age-old question that everyone with money to save or invest wants the answer to. In today’s low-interest-rate environment, however, there is no easy answer. The rule of 72 can help you understand how long it will take your fixed interest investments to double, but we’ll discuss why the rule of 72 goes out the window when it comes to stock market investing.
So What is the Rule of 72?
Simply put, if you divide 72 by the interest you are receiving on your fixed interest vehicles like bonds, savings accounts, money market accounts, and the like, you’ll know with relative certainty how long it will take for the amount to double. Let’s take a look at an example. Imagine you could still get a CD that would pay you 7.2% interest. If you could, your money would double in 10 years. 72/7.2 = 10 years.
However, we know that no such CD exists today. Right now, you can get a five year CD that pays a paltry 2%. So, if we divide 72 by 2, we know that it’s going to take a long time for that money to double. 36.5 years to be exact. As we’ve discussed in other articles recently, these currently low-interest rates are designed to do several things, one of which is to get you to put your money at risk in the stock market in order not to have to wait 36.5 years for your money to double. Conventional wisdom says that you should expect between an 8 and 10% return on your stock investments. Given those numbers, you would be forgiven for thinking that your money should double every 7-10 years. But does history bear that out? Sadly, it does not. I’ll explain it.
Does the Rule of 72 Work Historically?
Let’s go back to 1920. We’ve all heard of the roaring ’20s, right? And for the most part, they were. So let’s see how a $10,000 investment did in the 11 years from 1920 to 1930. There are a lot of places to find this historical information, the numbers I’m using come from Macrotrends.net. Here’s the return sequence for that period.
Figure 1 Source: Macrotrends.net
The ending value of our $10,000, after 11 years of owning the stocks that make up the Dow Jones Industrial Average, you would have $15,348. Not bad, but certainly not a double. In reality, even though there were 4 of the 11 years that had well over 20% returns, and one year that had a nearly 50% return, the average annual return for those ten years was only 4.86%. And other examples in history are even worse.
What About From 1930 to 1940?
Imagine you’d just gone through the ’20s and turned you 10,000 into $15,348, and you were excited for the new decade and the chance to grow your money over the next 11 years so that you could retire at the end of 1940. You would be sorely disappointed.
Figure 2 Source: Macrotrends.net
By the end of 1940, you not only didn’t have your $15,348 any longer, but you also didn’t even have the $10,000 you started within 1920. Your investment, from 1930 to 1940 lost 47.24% leaving you with $8,097. Absolutely gut-wrenching! Not only did you not double your money in 22 years, but you also had a negative 1% annual rate of return over that period.
How About More Recent History?
Let’s look at that same $10,000 investment beginning in the year 2000. Over the next 11 years, by the end of 2010, your investment would have grown to a whopping $10,069. An annual return of zip, zero, nada. No doubling, no 8% to 10% average annual return. Just a gut-wrenching rollercoaster ride courtesy of the stock market.
Figure 3 Source: Macrotrends.net
The point of all this is to state the obvious. We never know what the stock market, and therefore the portion of our assets allocated to it, will do in any given year or decade for that matter. Relying on rules of thumb and conventional wisdom to navigate the markets is a fool’s errand.
Understanding Risk is Key
This is why, especially in today’s low-interest-rate environment with an elevated stock market, it’s crucial to understand how much risk your portfolio needs to take to allow you to do the things that matter most to you. It should never take more than that. That might mean average returns sometimes, but it also means that you’re less likely to have to go through ten years with zero or negative returns, which is the point when you think about it. We need to have a positive number to divide 72 by. Even if it’s a meaningless rule of thumb where stock market returns are concerned, it’s still kind of fun. In the end, though, it’s far less important how long it takes your portfolio to double than how long it takes for it to lose half of its value.
Low Returns vs. Mismanagement
I’ve never seen low returns ruin someone’s retirement. I have, however, seen far too many retirements ruined for people whose portfolios were allowed to lose 50% by advisors who should have known better but didn’t.
Life is about a lot more than money, and our goal here at Barber Financial Group is to help you keep your money, grow it at a reasonable rate when it’s prudent to do so, and help you live your one best life focused on the things and people you care most about.
Now forget about the rule of 72, and do something you’ve been putting off, with someone you’ve meant to spend time with because life is too short not to!
If you have questions about your retirement plan, schedule a complimentary consultation below or give us a call at 913-393-1000. We’re always happy to discuss your goals for retirement.
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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.