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How I think the rule of 72 could help you get rich

Do you know how long it will take for the value of your investments to double?

Of course, no one can provide a guaranteed answer to this question. But if you own assets that provide stable returns each year, then you can make a useful estimate.

If you’re aiming to retire rich, I’d suggest this should be an important part of your retirement planning.

In this article, I’ll explain how you can use this simple rule to estimate future gains.

The rule of 72

The rule of 72 is a simple way to work out how long an investment will take to double in value, based on a fixed rate of interest.

All you do is to divide 72 by the expected annual rate of return. For example, 72/4 tells us that an investment which returns 4% per year should double in 18 years.

Applying the rule of 72 to a few common scenarios gives us some interesting numbers to work with:

 

Annual rate of return

No. of years to double

Best buy easy access cash ISA

1.44%

50

Best buy 3 yr fixed-rate ISA

1.9%

39

UK CPI inflation

2.1%

34

UK stock market (average long-term annual return)

c.8%

c.9

As you can see, even a small change in interest rates makes a big difference to future returns.

I hope you can also see that saving money in cash means that the value of your money will fall, after inflation. This is why trying to saving for retirement in cash is so hopeless.

One more example

You may think I’m exaggerating the importance of inflation. I don’t think I am. When I started my first proper job, I remember paying less than 70p per litre for petrol and under £2 per pint for beer.

Today I’m paying double those figures. The rule of 72 tells me that inflation on beer and petrol has averaged about 3.6% since I started work.

If you want your savings to help you get rich and retire comfortably, then you need to be earnings positive returns after inflation.

Investing to beat inflation

If you’ve got 20 years or more until retirement, I would suggest that the simplest and safest way to build a worthwhile fund is to put as much as you can each month into a FTSE 100 tracker fund (inside a tax-free Stocks and Shares ISA).

According to research by Barclays, the long-term average return from the UK stock market is about 8% per year. At that rate, it could take just nine years to double your money.

In reality, it will probably take a bit longer than this as stock market returns tend to come in cycles. But over long periods, history suggests the stock market is one of the best ways to build wealth.

Invest in dividend stocks

Rather than putting your money into a tracker fund, you might prefer to invest your cash in individual dividend stocks. This can be a surprisingly good way to generate reliable returns.

Income picks on my radar include companies like Royal Dutch Shell (6.4%), WPP (6.1%) and GlaxoSmithKline (4.8%).

The rule of 72 tells us that a dividend yield of 6% will double your investment in 12 years, assuming the shares stay flat and you reinvest the dividend income.

I hope I’ve shown how the rule of 72 is a powerful tool for financial planning. If you’re looking for more investment ideas, read on.

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Roland Head owns shares of GlaxoSmithKline, Royal Dutch Shell B, and WPP. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.