Predict your returns with this one weird trick!

Remember those “one weird trick” ads that used to be all over the place online? If you do, then you might be immediately skeptical when I tell you that today’s Tip is, in fact, about “one weird trick” that can be a major help in financial planning.

But unlike those ads lurking in sidebars from the New York Times to Buzzfeed, I promise this one’s legit.

To be specific, it’s a trick for estimating the number of years it will take for an investment to double in value, thereby giving a snapshot of that investment’s overall growth potential. Known as the Rule of 72, it’s proven time and time again to be surprisingly effective – for making estimates anyway.

The formula to exactly calculate the doubling period is this big hairy thing:

T = ln(2)/{ln[1+(r/100)]}

Multiple layers of division, logarithmic functions, and so on. If you just need a quick estimate to work with, it’s a real bummer – definitely not the kind of thing you can do in your head, probably not even on a cocktail napkin.

The Rule of 72, by contrast, whittles all that down to something much simpler:

T = 72/r

where “T” is the doubling time in years, and “r” is the rate of compounding interest.

So for example, if your IRA portfolio has an average return of 6% every year and you don’t add to or subtract from it, you can expect it to double in about 12 years (72 divided by 6), give or take. Doesn’t matter how much was in there to start with.

In case you don’t believe me, I’ve done the math for several different interest rates using both the Rule of 72 and the full formula. Notice how close the two results are every time:

Despite its simplicity, the rule of 72 can be surprisingly accurate for predicting returns

Why 72, you might be wondering? Well… you’d have to ask an actual mathematician. It is, in a word, weird. But very, very convenient too.