Understanding How the Rule of 72 affects your 401K

There are multiple factors that influence your 401K success but three factors have the most significant effects. The first and second factors are pretty simple save now and save as much as possible. The third one is a bit subtler and potentially more important. It involves the return you gain on your investments within your 401K funds.

The Rule of 72 is a simple math tool that computes how long it takes for an investment to double. Here’s how it works. If you divide 72 by the interest rate you have earned or the interest rate on your investment you are expecting the quotient is the number of years it takes the investment to double. For example, if you expect a 10% return on the investment you would take 72 and divide by 10 telling you that the investment will take 7.2 years to double if you earned 10% on your investment each year. If you received 6% on your investment each year you can divide 72 by 6 and learn that the investment will double every 12 years. And, if you are fortunate to earn 12% on your investment, taking 72 and dividing it by 12 tells you that the investment will double in just 6 years.

Sounds easy, but we all know that seeking and earning higher investment returns comes with increased risk. Factoring the number of years you’d like to save balanced by your risk tolerance helps you decide how much risk to take.

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