Rule of 72 – How Long to Double Your Money

Doubling your original investment is a common goal for investors, and understanding how long it will take to achieve this can help determine the effectiveness of your portfolio. The Rule of 72 is a simple tool that can help you quickly estimate the time required to double your money without the need for a complex calculator.

What is the Rule of 72?

The Rule of 72 is a straightforward formula used to estimate the number of years required to double your money at a given annual rate of return. Simply divide 72 by the annual compound return rate to get the approximate number of years it will take for your investment to double.

Formula:
Years to Double=72 over Annual Return Rate

For example, if your rate of return is 6%, you would divide 72 by 6, which equals 12. This means it will take approximately 12 years to double your money at a 6% annual return rate.

Real-World Examples

Let’s explore some real-world scenarios to see how the Rule of 72 can help you evaluate different investment options:

• Checking Account Rate: 0.01% $72÷0.01=7200\text{ years}$
  (Practically zero growth)
• Savings Account Rate: 1.05% $72÷1.05=68.57\text{ years}$
  (Super Saver Account)
• Registered Savings Bonds: 4% $72÷4=18\text{ years}$
  (Currently, the best bond rate is around 0.5%)
• Balanced Mutual Fund: 5% $72÷5=14.4\text{ years}$
  (Decent return for a mutual fund but challenging over a 14.4-year span)
• Growth Mutual Fund: 10% $72÷10=7.2\text{ years}$
  (High-risk mutual funds rarely sustain this over a long period)
• Investing in the Dow Jones: 9.5% $72÷9.5=7.57\text{ years}$
  (Historical average market gain)
• Investing in Solid Companies Paying Dividends: 14.4% $72÷14.4=5\text{ years}$
  (My first portfolio, created without many of my current rules)
• Investing in Solid Companies Paying Dividends: 32.8% $72÷32.8=2.2\text{ years}$
  (My second portfolio using my current rules)

Understanding the Importance of P/E Ratios

While the Rule of 72 is a useful tool, it is only one piece of the puzzle when evaluating investments. The price-to-earnings (P/E) ratio is another crucial metric that investors often use to assess whether a stock is overvalued or undervalued. However, it should not be the sole determinant in your investment decisions.

P/E Ratios for Established Businesses: P/E ratios are particularly useful for established businesses with a long history of stable earnings. For example, if a company has a high P/E ratio, it might indicate that investors expect high growth rates in the future. Conversely, a low P/E ratio might suggest that the company is undervalued or facing challenges.

P/E Ratios for Growth Companies: Growth companies, however, often have high P/E ratios due to their reinvestment strategies aimed at achieving higher future growth. For instance, in 2020, Amazon’s stock price was around $90 per share with a P/E ratio of 91. Many investors advised against buying Amazon, considering it overvalued. Fast forward to today, and Amazon’s stock price is roughly $185 per share with a P/E ratio of 64. Despite some experts still considering it overpriced, a long-term, buy-and-hold perspective reveals significant growth potential.

The Bigger Picture: Beyond P/E Ratios

While the P/E ratio is important, it’s crucial to consider other factors when evaluating a stock:

1. Growth Potential: Assess the company’s potential for future growth by examining revenue trends, profit margins, and reinvestment strategies.
2. Competitive Advantage: Determine if the company has a strong competitive position or “wide moat” that can sustain long-term profitability.
3. Market Conditions: Consider overall market trends and economic conditions that might impact the stock’s performance.
4. Diversification: Spread your investments across different sectors and asset classes to mitigate risk.
5. Fundamentals: Look at the company’s financial health, including debt levels, cash flow, and earnings consistency.

My Personal Experience

My experience with Amazon highlights the importance of looking beyond just the P/E ratio. Despite initial concerns about its high P/E ratio, Amazon’s strong growth in retail sales, AWS, and other revenue streams proved its value as a long-term investment. By focusing on a comprehensive analysis of the company’s fundamentals and growth potential, I was able to make a profitable investment decision.

Conclusion

The Rule of 72 is a valuable tool for estimating how long it will take to double your money, and the P/E ratio is an important metric for evaluating stocks. However, both should be used as part of a broader investment strategy that considers a company’s growth potential, competitive advantages, market conditions, and overall financial health.

By conducting thorough research and taking a long-term perspective, you can make informed investment decisions that align with your financial goals. Remember, investing is not about finding a single magic metric but about understanding the full picture. With patience, diligence, and the right mindset, you can navigate the complexities of the stock market and build a robust investment portfolio.

Happy investing!