Rule of 72
Among the most powerful things I learned last year: the Rule of 72 is one. It serves me as a good mental model to think about how your wealth grows.
We are primed as humans to think linearly and to approximate things using a straight line. It makes sense since a lot of change around us happens at a constant pace. I accumulate my monthly paychecks, I invest and that makes my retirement fund. I shared this in a talk at my alma mater as well since it’s had a deep impression on me for the sheer simplicity it relays.
When it comes to finances and investing, thinking linearly does not work. We need to think exponentially – money compounds. To me, compounding (wealth and self) has been hackneyed. I realize the implications but the mental model wasn’t as first nature as it is right now – better late than never. Money literally accelerates over time.
The rule of 72 is a trick that allows us to develop a mental intuition for exponential growth. This rule allows us to arrive at how many years it would take for our money right now to double. Of course, this is dependent on the interest you get.
Years to double = 72 / Annualized rate of return
For example: if you’ve deposited 10,000 in your an account that gives you 4% interest, it will take you 72/4 = 18 years for that money to double (become 20,000). It also means, 18+18 years from now, it would double again (to 40,000)
This makes intuitive sense as well. Since the rate of return is in the denominator for this rule of 72. As the rate of return increases, the years to double the money reduce.
Additionally, the rule thinks about doubling and does not need to know how much money you are starting out with. It only seeks to create an intuition for the horizon. Read this piece on Rule of 240 which speaks about the same principle from a 10X lens.
For example, if you can get a 10% interest, you can expect to double every 72/10 = 7.2 years. If you start with ₹5L today, with a 10% you double it to ₹10L around 7.2 years from now, and then ₹20L about 15 years from now. If your goal is to get to ₹1C on the ₹5L today, with consistency you reach that goal in ~30 years. So if you start with 1M$ today, in 7.2 years (in 2028) you end up with 2M$.
This is powerful as it forces us to think about doublings with a goal that doesn’t require the use of a calculator instead of how linearly how much we save contributing to savings.
Now a question you might have, how might I beat bank rates of return? Spending time researching definitely helps. Paying a carry to wealth managers or equivalently trying out mutual funds can go a long way. The equity markets too have now been democratized, and are open to buying equity in publicly traded companies.
Are bank interest rates sufficient? Not really. Inflation is very much real. Something you buy for 100 now, costs 107 with a 7% inflation rate (historically anticipated). Hence, by opting into principles of strong compounding you’re actually growing your wealth.
Einstein rightly claimed “compounding” to be the eighth wonder of the world. Compounding is literally what Warren Buffet has been doing for the last several years: by placing his hurdle rate at 15%, he doubles every 5 years. In his lifetime of 80 years, that is 80/5 = 16 doublings; enough to close in on that 1B$ in a lifetime.
Rule of 72 is a powerful mental model, and certainly transformative for those who appreciate it.