One of the more popular financial tricks in personal finance is referred to as the Rule of 72. Acting as a tool for quick estimations, the equation states that dividing the number 72 by the interest rate of an investment will show you how many years it takes to double your money in a given investment. As such, an investment into a savings account that pays 3% interest will double its principle amount in 24 years. Comparatively, an investment in a bond that pays 5% will double in 14.5 years. With that in mind, we can look at how it is that this rule can be taken a step further to evaluate our future wealth goals.
The first way to look at the ability of the rule of 72 to help us understand our ability to meet our long term financial goals is in terms of its applications in a portfolio. While we might have a bond that will double in 14.5 years, a portion of our money will still be in that savings account at 3% that will take 24 years to double.
If we have equal amounts of money in either of these products, we need to look at the average term values of these investments, and re-evaluate to determine how long it will take for the portfolio as a whole to double. We therefore need to divide each of these values by 2 (because they both make up half of our portfolio), and add them together. Continue reading