Please note: Everybody's financial situation is unique- a rule of thumb is only a broad indicator and does not replace a personalized solution. A rule of thumb may or may not be correct for your specific financial situation.
(Read our article titled 5 Personal Finance Tips for Before You Turn 40 )
1. How long will it take to double my money?
Have you ever had an investment salesperson insist that you must buy a certain product because it would double your money in 10 years? The next time this happens to you- do a small calculation to show the salesperson that you know more than he thinks!
The Rule of 72 helps you to calculate what rate of return it requires to double your money in a certain number of years. Alternatively, it can be used to show what number of years it will require to double your money at a particular given rate of return.
Here is how it works: Rate of Return required to double your money = 72 / Number of years
In the above salesperson example, a product that doubles your money in 10 years is giving you an annual rate of return of 7.20% i.e. 72 / 10.
With a 10 year investment horizon you might be better off investing the money into equity yourself and earning a higher rate of return over the 10 year period.
Similarly, Number of years required to double your money = 72 / Rate of Return
If you are earning say 15% on an investment, you can expect your invested money to double in 72/15 years i.e. 4 years and 10 months.
Remember however that the Rule of 72 is only a very broad approximation of the actual answer. To get a more accurate answer, use the number 69 instead of 72. The number 72 is used only because it is easily divisible by many numbers.
(Read about the Rule of 69 )
2. How much equity exposure should I have?
The broad rule is that your equity exposure should be equal to 100 minus your age. So if you are 35 years old, the equity component of your overall portfolio should be (100- 35)% = 65%.
However, this rule is again very broad and differs from situation to situation.
For example, if you have high liabilities and expensive financial goals that are coming up within the next 3 years, then the corpus for these expenses and goals should not be in equity, it should be in debt i.e. fixed income- or else with any major market volatility, the goals will be jeopardized. So keep your goal horizon in mind too.
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