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Successfully meeting your goals means knowing some important basics, like how much money to invest, how long it will take, and what average rate of return you can achieve. The better you can answer these questions, the easier it will be to plan your goals.

However, calculating these numbers can be intimidating. If you find it hard to set goals because the process seems too complicated, this popular rule of thumb might get you on the right track.

Reading: How long to double money in stock market

rule of 72 defined

The rule of 72 is a simple way to calculate how long it will take for your money to double based on an average annual rate of return. Using the rule, you take the number 72 and divide it by this expected rate.

For example, if you have a $10,000 investment that has earned or anticipates earning an average of 10% each year, it would take 72/10 = 7.2 years for your money to double. The more conservatively your money is invested, the longer it will take to double your money, and the more aggressively you invest, the shorter the time required. If you earn 12% on average, this rule calculates that your money doubles in 72/12 = six years. If you earn an average of 8%, your investment should double in about 72/8 = nine years.

rule of 72 based on different asset classes

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You can get a general idea of ​​how different asset allocation models have performed over the years using historical rates of return. over the 90-year time period between 1929 and 2019, here’s what the rule of 72 looks like for these different combinations of stocks and bonds.

data source: vanguard, author’s calculations.

pros of the rule of 72

The great thing about using this rule is that it’s incredibly simple. You don’t need a fancy financial calculator or computer program, just a piece of paper, a pen or pencil, and basic math skills.

You can then set some rudimentary targets using your calculations. Let’s say you have a goal of saving $50,000 for your child’s education in 18 years. you have $12,500 that you plan to invest now. Ideally, it should double to $25,000 in nine years and $50,000 in 18 years. Using the rule of 72, you could find out what average rate of return will accomplish this. After calculating this rule, you learn that it is 8% and you can invest your money accordingly.

limitations of the rule of 72

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If you were to invest 100% in stocks for 90 years, your average rate of return would be just over 10%. In general, the more time you give your money to grow, the better chance you have of capturing these types of averages. but over short periods of time, your averages may fluctuate more and not be as predictable.

The average returns you get from the stock market also depend on the length of time you invested and may vary. For example, if you invested in spdr s&p 500 etf (spy -2.28%) for the last 15 years, over a five-year period, you would have earned 15.12% on average. . over 10 years, that average return would be 13.49%, and over a 15-year period, 9.53%.

But if you had invested your money in the same ETF since 2000, your results would be very different. having experienced the dot-com bubble so much, his five-year average would be -0.71%. the great recession would have also hurt its returns, taking its 10-year average to 1.2% and its 15-year average to 6.09%.

Using this rule could also make investing just for a higher rate of return tempting, so you’ll have a shorter doubling period. But the higher the rate of return, the more volatile the investment could be. If you fall into this trap, your portfolio may not be invested according to your risk tolerances, which could make it difficult to stay the course during bear markets. if you can’t because your investments are too aggressive, the numbers you calculate are invalid.

The Rule of 72 can help you make quick and easy calculations that can help you set goals and start the financial planning process. but given your limitations, you should probably go ahead with more extensive planning. You should also make sure that you review your accounts on a regular basis, such as once a year, so that you can account for extremes in the stock market in any way and make adjustments accordingly.

Source: https://amajon.asia
Category: Stocks

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