“The most powerful force in the universe is compound interest”. Albert Einstein
The rule of 72 allows one to quickly determine how long it will take, at a given interest rate, to double your money on and investment.
For instance, if you have $1000 that is earning interest at the rate of 10% per year, how long will it take for the investment to grow to $2000, assuming all interest payments are reinvested at the same rate?
Your first instinct may be to say that the it will take 10 years, since 10% of $1,000 is $100, and it will take 10 years to add an additional $1,000 in earnings.
The actual time is approximately 7.2 years, which we get by dividing 72 by our interest rate 10. The reason this works is due to the magic of compound interest.
Interest compounds as you begin to earn interest on previous interest. Returning to our example, at the end of year one, you will have $100 in interest earning adding back to the principal balance giving you $1,100. At the end of year 2, you will have $110 in interest income. The additional $10 of income was produced from you adding the $100 earnings of year one back to the principal balance. As your earnings on your “retained” interest grows, you will quickly see an escalation in yearly interest income, culminating in your initial investment doubling in about 7.2 years.
To summarize, to determine how long it will take for an investment to double given a fixed interest rate, divide 72, by the expected rate of return (the interest rate).