Yahoo Finance What is the 'Rule of 72' and how can it inspire Americans to save more for retirement?
According to Federal Reserve data, the median retirement account balance among Americans was only $86,900 as of 2022. And there's a good reason for that. After all, it’s hard to save for retirement when more immediate bills need to be paid.
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But the fact remains that the sooner you start investing for retirement, the more likely you are to meet your desired savings goals. Once you’ve established those goals, the “Rule of 72” can help you determine how long it will take to reach them.
How the Rule of 72 works
The Rule of 72 is a calculation that estimates how long it will take an investment to double based on a specific yearly return. Simply divide 72 by your anticipated rate of return to get the number of years it will take for your money to double.
For example, if you expect an investment to generate a 6% yearly return, you’d divide 72 by that number to get 12 — meaning, you should expect your money to double every 12 years.
On the other hand, if your portfolio earned an average of 8% per year, you would double your money in nine years.
Applying the Rule of 72 to your retirement savings goal
Here’s how the Rule of 72 might work in the context of your retirement planning. Let’s say you’re 35 years old with $100,000 saved for retirement to date. Let’s also assume that your portfolio generates an average yearly 7% return, which is below the S&P 500’s historical average, per the Official Data Foundation.
Using the Rule of 72, your money should double every 10.3 years. So, by age 45, you should have around $200,000 in retirement savings. By age 55, you should have around $400,000. And by age 65, you should have around $800,000.
Remember that this does not consider any additional contributions you make during this period.
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Problems with the Rule of 72
The Rule of 72 can be useful as you work toward your savings goal. However, there are some flaws you should consider.
First, the Rule of 72 assumes an average yearly return to calculate a specific period of time. While this calculation might work well for fixed-rate assets such as certificates of deposit and bonds, applying the rule to the stock market is more difficult. If you’ve followed the stock market’s history, you know that returns can vary wildly from one year to the next. And historical averages do not guarantee future returns.
This is why it’s helpful to use more conservative rates of return when using the Rule of 72 with an equity-heavy portfolio. While the S&P 500 has historically returned around 10% annually, a safer figure to use would be 7% or 8%.
Secondly, the Rule of 72 shows you how long it would take to double your money based on your existing savings balance. It doesn’t take into account further contributions. In an odd and perhaps unintended way, it may send the message that if you’ve saved a certain sum by a certain age, you’re okay to stop saving, period. But ideally, you should continue to add to your savings if you can — not just for the extra money down the line, but also for the potential tax benefits that come with funding an IRA or 401(k).
What you should take away from the Rule of 72
The Rule of 72 isn’t perfect, but it may inspire you to start saving for retirement earlier than you had originally planned. It may also motivate you to pump extra money into your retirement savings so that you can capitalize on compounding growth.
All told, it’s a great idea to front-load retirement plan contributions during your early years of working and let that money grow passively via a portfolio of stock investments. If you can do that while continuing to add to your savings, you could end up with a balance far exceeding the typical American.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
