Many people when considering investing have uncertainty about whether their investment will have good returns or not. This may be concerning for many investors as not all investments turn out to be good ones. A solution to this problem is the rule of 70. The rule of 70 can help investors easily determine how good an investment potentially is. This article will help answer all the questions that may come to mind when learning about the rule of 70.
What is the Rule of 70?
The Rule of 70 is a simple mathematical estimation used to determine the approximate number of years it will take for an investment to double in value. It works by taking 70 and dividing it by the expected annual rate of return on the investment. The resulting number is the approximate number of years for the investment to double. While it provides only an estimate, the Rule of 70 can be a useful tool for investors to gauge how long it might take different assets to grow at varying rates of return.
What is The Rule of 70 Formula?
The basic calculation behind the Rule of 70 is:
70 / Annual Rate of Return = Approximate Number of Years to Double
Let’s break this down:
– 70 is used because taking the natural logarithm of 2 is approximately equal to 0.693, and 70 is a rounded number close to 100/0.693.
– The annual rate of return is expressed as a percentage, such as 5% or 10%. So we would enter it into the calculation as a decimal, i.e. 0.05 for 5%.
– We take 70 and divide it by the annual rate of return to determine the approximate number of years it will take an investment earning that return to double in value.
For example, if an investment was expected to return 5% annually, using the Rule of 70 we would calculate:
70 / 0.05 = 14
This means it should take approximately 14 years for the investment to double at a 5% annual rate of return.
Why is the Rule of 70 Useful?
The Rule of 70 provides investors with a simple way to gauge the growth potential of different assets without complex calculations. Some key reasons it can be helpful include:
– Compare Expected Returns: It allows comparing doubling times to help choose investments with potentially faster growth.
– Set Growth Expectations: Gives a baseline for how long savings or investments may take to reach a target at a given rate of return.
– Make Informed Decisions: Quickly estimate outcomes to determine if returns seem achievable for goals within set timeframes.
– Demonstrate Power of Compounding: Highlights compounding’s strong effect over time, showing the importance of maintaining investments for long periods.
While not exact, estimations of this rule often come fairly close to more precise compound annual growth rate calculations, especially over longer durations. Its simplicity makes it a useful visual tool for framing investment decision-making processes.
To better demonstrate how the Rule of 70 can be applied, here are some examples of doubling time estimates for common asset classes:
– 5% Average Annual Return:
70 / 0.05 = 14 years
Investments averaging 5% returns should double approximately every 14 years.
– 8% Average Annual Return:
70 / 0.08 = 8.75 years
Assets returning 8% on average will double roughly every 9 years.
– 10% Average Annual Return:
70 / 0.1 = 7 years
High-growth investments targeting 10% annual gains will likely double every 7 years.
– 12% Average Annual Return:
70 / 0.12 = 5.83 years
Outperforming holdings at 12% may realize doubling roughly every 6 years.
Seeing how different rates of return correspond to doubling periods makes it easy to gauge growth potentials over various durations. This helps rank asset choices, set savings goals, or identify the long-term compounding impact of returns.
What Are The Drawbacks of Using the Rule of 70
While a useful investment concept, it’s important to note some limitations of the Rule of 70 estimate:
– Not Exact: It provides an approximation, not a definitive doubling period. Returns often fluctuate from year to year.
– Impact of Withdrawals: Account withdrawals slow the doubling process by reducing investment balances and missed returns.
– Inflation Effects: Rising prices erode the real purchasing power of returns over long periods of inflation.
– Taxes: Capital gains and income taxes diminish real after-tax investment growth.
– Variable Returns: Future market conditions, economic cycles, or individual security performance may produce different long-term average returns than expected.
Therefore, while this rules estimations can help with conceptualizing compound growth, it does not replace detailed financial planning based on an individual’s distinct goals, situation, and risk tolerance. Expect some variance from doubling time predictions.
In summary, the Rule of 70 is a simple yet useful investment concept for getting a general idea of how long savings or investments may take to double at a given expected rate of return. Demonstrating the power of compounding growth over time, helps investors gauge potential outcomes from different assets and plan accordingly.
Of course, investment returns usually prove more variable than this rule suggests. However, the principle still offers value as an introductory tool to appreciate exponential investment growth. With limitations in mind, the Rule of 70 offers a simple way to figure out long-term goals for building up wealth at the onset.
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