The Rule of 72
Charles B. Carlson, CFA
Contributing Editor, Dow Theory Forecasts
If your portfolio doubled in value over the last four years, do you know what your average annual return was during those four years?
The "rule of 72" provides an easy tool to determine average annual market returns. The rule says the following: Take the number 72 and divide that by the number of years it took your portfolio to double (assuming you put no new money into the portfolio). That's our average annual return.
Let's return to our example. If you divide 72 by 4, the result is 18. The average annual return for a portfolio that doubles in four years is approximately 18 percent. What if your portfolio doubles every 10 years? Dividend 72 by 10 gives you 7.2. In other words a portfolio or individual stock that doubles in value in 10 years has an average annual return of 7.2 percent.
You can use the rule of 72 to determine how long it will take a portfolio earnings X amount each year to double. Say you have your funds in a money-market account earning 5 percent. By dividing 72 by 5, you know that it will take your funds a little over 14 years to double in value. What if you can increase your return to 8 percent? Your money now doubles in nine years.
One advantage of the rule of 72 is that it provides an easy way to gauge the value of boosting a portfolio's return an extra 1 or 2 percent each year. A portfolio that earns 9 percent a year doubles in eight years. A portfolio that increases an average of 10 percent per year doubles in a little over seven years.
The rule of 72 also makes it easy to put the stock market's long-term performance in perspective. Recall that the stock market's average annual return since 1926 is just under 11 percent-not the 15 percent, 20 percent, or 30 percent annual returns posted in the 1990s. Dividing 72 by 11 means that money in the stock market since 1926 has, on average, doubled every 6.6 years.
Keep that in mind the next time you start whining that it took a whole five years for your stocks to double in value. (What's a doubling in five years? An average annual return exceeding 14 percent.)
|
