Rule of 72 and Other Investing Rules-of-Thumb
I love trivia – it combines a few of my favorite things – getting together with friends, random knowledge, and being right. My trivia team (Scott’s Tots) has been enjoying really great questions at Great Mane Brewery’s A+ Trivia, and recently one of the categories was “The Number 72” and all the questions related to that number.
The first question was:
“According to the Rule of 72, if you know the annual interest rate of an investment, what can you figure out?”
If you would like the answer to that question, and to learn about some other “rules” related to investing and savings, read on! And if you want to test your wit on questions related to the number 72, find the full set of questions at the end of this blog.
What is the Rule of 72
The simple, and trivia answer is the Rule of 72 is an estimate of the number of years an investment will take to double in value, assuming a fixed interest rate. For the history buffs who want to be ready for really obscure trivia, the Rule of 72 dates back to 1494, when Luca Pacioli referenced the rule in his comprehensive mathematics book called “Summa de Arithmetica”.
Example: With an interest rate of 6%, it will take roughly 12 years for your investment to double because 72 / 6 (interest rate) = 12 years
This rule serves as a reminder of the power of compounding interest rates and how significantly you can grow your wealth over time. As mentioned, it is an estimate and does not take into consideration other influences like varying interest rates, market conditions, dividend payouts, and more.
The Rule of 72 should also be stark reminder of how quickly debt can double because the same math applies. According to Forbes, the average overall credit card rate is 25.27%. At that rate, it will only take 2 years and 10 months to double your credit card debt (72 / 25.27 = 2.85).
Source: https://www.investopedia.com/terms/r/ruleof72.asp
10, 5, 3 Rule
The 10, 5, 3 Rule offers a general framework for investors when thinking about asset allocation and long-term return expectations. It suggests that, on average, stocks may return around 10% annually, bonds about 5%, and cash roughly 3%. These numbers are not guaranteed and can fluctuate significantly depending on investment type, economic conditions, and market performance. Still, the rule serves as a useful starting point for building a diversified portfolio with a mix of growth and stability. By combining higher-risk assets like stocks with more conservative ones like bonds and cash, investors can create a balanced strategy to help weather market volatility.
Because of its limitations, the rule should be applied with a significant degree of flexibility. It’s important to periodically review and adjust your investment portfolio in response to changing market conditions and personal financial goals.
15% rule
The “15% Rule” is another rule of thumb that says that you should save at least 15% of your pre-tax income for retirement during your working years (25 to 67). The theory is that with compounding interest, saving that 15% will allow you to spend about 55% to 80% of your pre-retirement income when savings are combined with Social Security.
Is 15% enough? That depends on many factors like the choices you make prior to retirement — most importantly, when you start saving and when you retire. If early retirement is a goal, savings targets will need to be higher, and if you plan to work longer, you may not need to save as much. Additional considerations include your marital status, other income sources you may have, such as a pension, should also be considered.
The best way to determine what you need to be saving for retirement is working with a financial planner to build a holistic financial planning that takes into account all the different facets of life and finances.
In addition to the 15% rule for retirement savings, there are also the 4% and 8% rules for retirement withdrawal.
Age x Income / 10
The “Age × Income ÷ 10” formula is another hypothetical rule of thumb used to estimate how much wealth a person should have accumulated at a given age. By multiplying your age by your annual income and dividing by 10, you get a benchmark for whether you’re on track with building net worth.
For example, a 40-year-old earning $80,000 should aim to have a net worth of around $320,000.
Unlike the rule of 15% above, this rule referrals to your overall net worth.
Net Worth = Assets – Liabilities
Assets include liquid assets like bank accounts, CDs, investments, retirement accounts, and illiquid assets like your home and other real estate. Personal property such as vehicles, furniture, and clothing should not be included as assets. Liabilities are your debts, including credit card balances, car loans, home mortgages, student debt, and business loans, personal loans, etc.
While it doesn’t account for individual circumstances like lifestyle, or regional cost of living, it provides a snapshot of financial progress and may help you determine if you’re moving in the right direction.
The Gap Between Guidelines and Goals
While all the “rules” listed above provide tidy estimates, the reality is that life is never that simple and finances are not linear. It is always recommended to get individual guidance tailored to your specific financial situation and goals. A financial advisor can provide personalized guidance on how to apply (or not apply!) these rules to your particular circumstances, help you understand the potential risks and rewards, and provide additional options to consider. They can also help you create a comprehensive financial plan that factors your long-term financial goals and needs.
Trivia Questions About 72
- In the PGA Tour, 72 is significant because that is the typical par for a round, but 72 is also the number of what?
- Hafnium is element #72 on the periodic table. What is its symbol?
- 72-year-old Lynnea set the Guinness World Record as the oldest person to cross America (north to south) using which method?
- The 72nd Academy Awards was one of nine ceremonies hosted by which celebrity?
- If an MLB player hit 72 home runs this year, would they break the single-season record?
- A man spent 72 hours in a cage with 72 of these creatures to prove they are not harmful unless provoked. What were they?
(Answers: 1. Holes in a tournament (4 rounds), 2. Hf, 3. Bicycle (took 43 days), 4. Billy Crystal, 5. No (Barry Bonds holds the record with 73), 6. Snakes)