If doubling your savings in 10 years sounds unrealistic to you, your suspicions are correct – so long as you choose to keep that money in a savings account. Given that most savings accounts will only earn you an average annual return of one percent at best, it would take a whopping 72 years to increase your savings from, say, $10,000 to $20,000. But if you choose to invest your savings in the stock market, the Rule of 72 states that its perfectly reasonable to expect it to double within 10 years – or even less! But wait, whats the Rule of 72?
The Rule of 72
An old favorite of financial planners based on compound interest, the Rule of 72 is a simple way to calculate how long an investment takes to double with a fixed annual interest rate. Basically, the rule states that the amount of time required to double your money is equal to 72 divided by your rate of return (assuming that you reinvest your dividends and capital gains). So if you invested $10,000 at an annual interest rate of 10 percent, it would take 7.2 years (72 divided by 10) to become $20,000 dollars.
Returns and the Stock Market
To understand how much you can realistically expect to make from investing your savings in the stock market, its helpful to look at average annualized returns over a 25-year period. According to the Standard & Poors 500 Index (commonly referred to as the S&P 500, which represents nearly 70 percent of all publicly-traded stocks), the average annualized return from 1987 to 2012 was 9.61 percent. So if you had invested in an index fund that tracks the S&P 500 in 1987 and never withdrew any funds, you would have seen average returns of 9.61 percent every year – and doubled your money every 7.5 years.
The possibility of annual returns approaching the double digits is why so many people invest their savings in the stock market, as opposed to stashing money they dont plan on touching for decades into savings accounts that cant even keep up with inflation. That said, its important to understand that annual returns can vary wildly from year to year. Between 1987 and 2012, the market yielded returns as high as 37 percent in 1995 and as low as -37 percent when the market crashed in 2008. While it may be tempting to buy more shares when stocks are climbing or sell off all your holdings during a decline, you stand to benefit more from consistency – and from staying in the market through thick and thin. Especially when it comes to your savings, its the long-term averages that matter.
The Buffett Factor
In 2013, billionaire investor Warren Buffett predicted long-term annualized returns for the US stock market in the 21st century would be considerably lower than those experienced in the latter part of the 20th century: somewhere between six and seven percent. After adjusting for inflation and accounting for dividends, seven percent also happens to be the S&P 500s average annual return for the period spanning 1950 to 2009.
So lets apply the Rule of 72 to Buffetts prediction. If you invest $10,000 at an annual interest rate of seven percent, it would take 10.3 years (72 divided by 7) to become $20,000. So based on Buffetts prediction, the Rule of 72 states that youll double your money in approximately 10 years.
While historical data indicates that the Rule of 72 generally applies to investments, its a theory – not a fact. The same goes for predictions about future average annualized returns – even ones that come from Warren Buffett, arguably the most successful investor of all time. When it comes to the stock market, past performance is not necessarily indicative of future results. Because of the risks associated with investing, you should always consult a financial advisor before making any financial planning decisions – especially when it comes to your savings!