A Quick and Easy Way to Estimate Growth and Cost of Compounding: The Rule of 72
Whether you are saving for a goal or dealing with debt, the Rule of 72 offers a simple, yet effective way to estimate the time it takes for money to grow or for debt to balloon due to compound interest.
For example, if you’re deciding between two savings accounts, you can use the Rule of 72 to figure out which one will help your money grow faster. Or, if you have a loan and want to know how much it might grow while you're not making payments, the Rule of 72 can give you a quick idea of the long-term cost of the interest.
Let’s break it down into manageable pieces so you can start applying it today.
What Is the Rule of 72?
The Rule of 72 is a quick formula that estimates how long it takes for money to double, whether it's an investment or a debt. The calculation is simple:
72 ÷ annual interest rate (%) = number of years for money to double.
This formula works for savings and debt, showing how compound interest can either grow your wealth or magnify your financial obligations.
Why Should You Care About the Rule of 72?
Financial concepts like saving and investing might seem like distant concerns for students and young adults, while debt often feels unavoidable. Whether you are saving for a goal or managing debt, the Rule of 72 gives you a clearer picture of the power of compound interest.
- For Savings: It shows how your money can grow over time, motivating you to start early and stay consistent.
- For Debt: It reveals how high-interest debt can quickly spiral out of control, encouraging smarter borrowing and faster repayment.
Understanding the Rule of 72 can offer valuable insight into the power of compounding and deepen your awareness of:
- How small financial decisions today can lead to big outcomes over time.
- The importance of starting to save as early as possible.
- The potential risks of high-interest debt and how quickly it can grow.
Let’s explore how this rule works in real-life scenarios
Example 1: Savings – How Your Money Grows
Imagine you receive $1,000 as a graduation gift and invest it in a savings account or index fund with a 6% annual return. Using the Rule of 72:
72 ÷ 6% = 12 years
- In 12 years, your $1,000 will double to $2,000.
- If you leave it untouched for another 12 years, it will double again to $4,000.
Takeaway: Start saving early. Even small investments today can grow significantly over time, thanks to the power of compounding.
Example 2: Debt – How It Can Balloon
Now, let’s consider debt. Imagine you have a $1,000 balance on a credit card with an 18% annual interest rate. If unpaid, here’s how long it will take to double:
72 ÷ 18% = 4 years
- In 4 years, your $1,000 debt will grow to $2,000.
- Another 4 years later, it will double again to $4,000.
- This does not include late fees and penalties that would be added to the debt for non-payment.
Takeaway: High-interest debt grows alarmingly fast. Always aim to pay more than the minimum balance to avoid falling into a debt trap. Many credit management resources can be useful if you're in this situation.
Comparing Savings vs. Debt
| Scenario | Rate | Time to Double |
|---|
| Savings | 6% | 12 years |
| Credit Card Debt | 18% | 4 years |
The difference is clear: With savings, compounding works for you. With debt, it works against you.
How Can You Use the Rule of 72?
1. Start Saving Early:
- Open a savings or investment account and make regular contributions.
- Even small amounts, like $50 a month, grow significantly over time.
2. Avoid High-Interest Debt:
When able,
- Pay more than the minimum.
- Only use credit cards for amounts you can repay each month.
- Pay off high-interest debt quickly to save money and reduce stress.
The vast majority of students have to carry over a balance at some point if not regularly, so we should try to be realistic about making something to avoid, not to beat yourself up about when it's not possible. You can have a look at our podcast Making Cents of Money, Badges courses, and webinars dealing with debt for more information.
You can listen to this episode on on SoundCloud, Apple Podcasts , YouTube Music, or Spotify.
3. Set Financial Goals:
Use the Rule of 72 to estimate how long it will take to double your savings for goals like studying abroad, buying a car, or starting a business.
Stay proactive about managing debt to keep financial goals on track.
Final Thoughts
The Rule of 72 is a simple yet powerful tool that makes complex financial concepts easier to understand. Whether you’re saving for the future or managing debt, applying this rule can help you:
- Make better financial decisions.
- Build your savings.
- Avoid financial pitfalls like high-interest debt.
Start practicing now—double your knowledge, double your money, and steer clear of doubling your debt!
