A quick way to estimate how long it will take to double your money. Use this to determine what target return you need to achieve to meet your timeline. Plus, options for finding higher returns.
One of the biggest factors in determining when you achieve financial independence is the performance of your nest egg. After a few years of diligently saving 30-70% of your income, you will have created an extremely valuable asset base that can do work for you while you sleep. Through compound interest, your nest egg will be contributing a huge chunk of the work necessary to get you to retirement.
In fact, when I retired about 60% of my nest egg came from savings while 40% came from my money doing work for me. If you work longer than I did, your nest egg’s passive contribution will probably be greater than 40%.
As you think about various timelines for your retirement, it’s helpful to have an easy way to think about the relationship between the performance you need from your nest egg and the amount of time it takes to retire. Enter the Rule of 72.
What is the Rule of 72?
The rule of 72 is an easy way to estimate how long it will take your money to double at a given return rate. Compound interest is governed by exponential equations. To solve an exponential equation requires a logarithmic function. Most of us don’t walk around doing logarithmic functions in our head, but division is pretty easy by comparison. With the Rule of 72, you simply divide 72 by the percentage return you expect to get the amount of time it takes to double your money.
Rule of 72 – Doubling Time
|Annual Return||Years To Double|
Low Rates Nuke Your Retirement Timeline
Looking at this chart makes one thing very clear. A point of difference at the very low end of the spectrum is extremely punishing, more so than a point of difference in the mid or high range.
A point of different at the low range adds decades to your timeline. If you are putting your money in low-yield CD’s or a savings account, it’s going to take more than 36 years to double your money.
If you want to retire early, you cannot afford to leave the bulk of your money in these types of vehicles.
Don’t Forget About Inflation and Taxes
The Impact of Inflation
Maybe you think that 7% mark looks nice. I do, too. Doubling in 10 years seems pretty reasonable. And I can think of a few asset classes that have had 7%+ historical returns. This sounds realistic. However, to achieve that 10-year double, you need to be clocking a 7% real rate of return, meaning you’re taking into account inflation. Inflation averages about 2% a year. That means you are seeking a nominal return of approximately 9% a year so that your money has double the purchasing power in 10 years than it has now.
Now add a little more cushion because you’ll be paying taxes on all your gains. You can start to see why finding a tax-optimized strategy matters. Given the choice between municipal bonds paying 5% that are tax exempt and a bond fund that pays 6 or 6% but are not federal and state tax exempt, I am very likely to take the muni bonds. If my total marginal tax rate is, say, 33%, my net gain is only 4% after taxes on the other bond fund, versus a pure 5% on the muni fund. In fact, I just picked up some muni bonds this past month for that reason.
If you are investing out of a tax-advantaged account like a 401k or an IRA, you do not have this concern. And this is a huge advantage. While you may have to pay taxes on the money you eventually withdraw, you get to keep many dollars working for you for decades that you would have ordinarily had to pay out in taxes on the gains throughout the years.
Let’s talk about regular, taxable accounts for a minute. Tax impact has huge implications on how you should choose to deploy your money. We have talked a lot about the performance of a long-term index fund strategy on this blog. One of the benefits of this strategy – particularly for money in your taxable accounts – is that you are not buying and selling over the years, which means you realize no gains. If you realize no gains, you are not paying taxes along the way, which means you keep all those dollars working for you for a while longer that might have gone to the tax man.
When evaluating more active strategies for your taxable accounts, you should consider the net after-tax return. If you think actively buying and selling options or stocks can yield you one to two points more per year in gains but your marginal tax bracket is high, you are probably worse off actively trading than you would be parking your money in a long-term index fund strategy.
Where To Find Higher Returns
Looking at this chart shows you how powerful it can be to add just one extra point to your average annual return. For every million dollars you deploy, a one point additional gain is $10,000 a year, more in the outer years because of the compounding effect. You can start to see that at some point, managing your assets slightly more efficiently will be more impactful to your financial future than your full-time job, or all your savings efforts combined.
What are you invested in now, and in what proportions?
If you don’t yet have a single pane of glass to view your nest egg, I highly recommend implementing one. My favorite is Personal Capital’s free net worth and expense tracker.
You can see across all your accounts what funds, bonds, etc. you hold, and how they add up percentage-wise across your portfolio. You’ll easily be able to tell what percent exposure you have to different asset classes across all your accounts, and it includes expense benchmarking so you can determine whether you are overpaying for your funds and mind switch to near-identical funds that will cost you less.
For the Ultra-Conservative: Low-Hanging Fruit
If you are sitting in all cash or low-yield CD’s, you have ridiculous opportunities to accelerate your financial independence. Almost anything else on the risk-reward spectrum will boost your timeline by several decades. If you are extremely risk averse and making only 1% in a savings account, you can probably get behind the safety of investing in municipal bonds that are backed by government tax revenue. These can yield 2-3%. That moves your doubling time from 72 years to 24 in one fell swoop. Hopefully with some research you will feel comfortable moving even further up the risk spectrum into stocks, other kinds of bonds, etc. which have even higher expected returns. But this would be a huge start.
For most people who already have some investments in stocks and bonds, the easiest change to achieve higher returns is to tweak your allocation between the two. It is my belief that most target date funds hawked to the average worker through their 401k are overweight on bonds for the financial situation of the purchaser. I talk more about optimal portfolio allocation here, where you’ll get the tools and performance data to decide for yourself what allocation makes sense. Re-balancing your allocation in this way could easily add a point or two to your expected returns.
Alternative investments are investments that are not the conventional choices of stocks, bonds, and cash. Things like private equity, venture capital, and real estate all fall into this bucket. Alternative investments can often yield much higher returns than their conventional counterparts.
Of the options available in alternative investments, the one I’m personally most interested in is real estate. If you owned property in San Francisco for since 2000 (including the huge dip of the subprime housing crisis in 2008), you would have seen close to 6% appreciation. Assuming a standard mortgage, your return would have made about a 15% CAGR over that 17 year time period. That’s way better than the S&P’s 4.5% CAGR during the same period. Granted, 2000 was the year of the internet crash, but a 15% CAGR is still 5 points higher than the the stock markets historical 30+ year performance.
Not every market will look like San Francisco, but there are all sorts of interesting opportunities in real estate, and you are competing with a much smaller, localized group for opportunities vs. trying to eke out a better return than others in something like the stock market. If expensive, quickly appreciating housing markets spark fears of a housing bubble in you, you might consider rental properties that are purchased for income rather than appreciation. Properties near universities can often yield 10%-12%+ returns. Note that these types of investments often require more work than clicking ‘Buy’ for a stock, but you are rewarded for it in your higher returns as well as the ability to invest in an asset that you perhaps feel like you understand better and which has tangible, physical value.
Real estate is hyperlocal, and whether or not it makes a good investment is highly dependent on individual market characteristics. You can check out my spreadsheet for evaluating a home as an investment as a place to start.
The list of interesting opportunities is endless. Tax liens, rehab projects, peer to peer lending…these require time to understand and evaluate, but they are certainly out there.
The Rule of 72 can help you hone in quickly on the performance you need to achieve to meet your desired timeline, and narrow your focus to the kinds of assets and investments it will take to get there. Use it to sharpen your picture of what it takes to get you to where you want to go.
What are you targeting as your timeline for achieving financial independence? What return is required to get you there?