#75: The rule of 72 (and its oft-overlooked implications)

21st February, 2022

Welcome to the Idiot Money newsletter. This week, becoming wiser with money by understanding the financial returns, far from being an unequivocal objective scorecard, are primed to mislead you… but one simple sum can help.

(And yes, this being Idiot Money #75, I obviously should’ve posted this three weeks ago)

The most useful number in personal finance is 72.

The ‘Rule of 72’ is an easy way of comparing investment returns over the only period that matters to investors looking for a greater life rather than a greater fool. One measured in decades, not time between Bitcoin peaks and troughs.

It’s also a good way of getting people who never shut up about house prices to shut up about house prices.

The Rule of 72 tells you how long it takes an investment to double, based on its growth rate (or the growth rate, based on how long it takes to double).

72 divided by annual growth rate = time taken to double.

72 divided by time taken to double = annual growth rate.

How long would an investment growing at 5% take to double? 72/5 = 14.4 years. Getting 20% growth? Now it takes only 3.6 years.

What return would you need for something to quadruple in value in 30 years? That’s doubling twice, so 72/15 = 4.8% per annum to quadruple in 30. Thus did a 30 year-old’s £250,000 house or retirement pot become a 60-year old’s £1,000,000 with a pretty mediocre return.

So far so mundane. But being able to quickly do such calculations has handy implications.

First, it’s a useful way to quickly link any question of arbitrary investment returns to something more meaningful. It’s easier to picture what difference something would have if it doubled in value (and maybe doubled again, and again) than if it ‘grew at 7%’.

And second, assuming you’re not a member of the Liberal Democrats’ famous Bullshit Graphs Squad, if you’re going to compare things, you’re going to want them in a vaguely comparable format. Annualised growth is a fair-enough means of doing this.

Apples and apples

Say you heard someone brag about how they bought a property ten years ago that had since doubled in value. Sounds impressive, you may think. But how impressed should you be? Should you be impressed enough to let it affect your own investing strategy?

One of the (many) problems with property as an investment is that unlike other investments, which usually make the news only with reference to their daily movements, property is usually talked about over timeframes of at least a year.

This should be a good thing. All investments as they relate to people more interested in funding lifestyles than trading jpegs should ideally be talked about in multi-year terms. But because they’re not, it makes the fact that property is a source of many misleading ideas about investing.

A property that’s doubled in value in 10 years has grown at 7.2% a year. 72 divided by 10 years = 7.2% annual growth.

Still not bad, though rather less viscerally engaging – and thus less prone to distorting vision – than ‘doubled!’ Especially when compared to typical long-term stockmarket returns. And especially if you capitalise your time and energy costs and knock them off the return, as of course you absolutely should.

This isn’t to dunk on property. It may be relatively silly a lot of the time, but it’s still absolutely most people’s best investment precisely because they don’t bugger about with it. And while Daily Mail distribution is disappointingly endemic, most people are sane enough to think about things other than house prices at least some of the time.

Extra credit

It’s helpful, too, to be broadly aware of the average annualised ten-year return of the major global stockmarkets (which is about 11-12%, and which you can capture for essentially zero time and energy costs, assuming you’ve grounded such capturing on a decent philosophy).

And it’s definitely best to think about it as the average annualised ten-year return, not the average annual return, even though they’re in effect the same thing. Because stockmarket returns are rarely within an average range over a 12-month period (though you’re probably not investing for only 12 months anyway, so this is only a problem if you choose to set stupid expectations).