The Rule of 70 and Its Applications
What is the rule of 70 and how is it useful to investors like you?
The rule of 70’s duration is usually in years. To get this estimate, one takes the number 70 and divides it with the variables growth rate. This estimate is used together with a yearly compound interest rate in order to know the duration it will take for one to double their money.
This rule is useful in many aspects. In the case of government in relation to the economy, the rule of 70 applies in gauging how long the Gross Domestic Product will take to double.
An illustration could be as follows: If the growth rate is 10%, then you simply divide the 70 with the growth rate of 10%. When you calculate this, the answer will be seven. Hence, it will take seven years for the country’s Gross Domestic Product to double.
The rule of 70 example
Let’s take a case of an investor who invests about $20,000. The annual interest rate is 10%. For the investor to estimate how many years it will take for his/her investment to double, the calculation will be 70/10=7. Thus, it will take seven years for the investment to double to $40,000.
The rule of 70 is quite simple to apply. It doesn’t involve complex mathematical procedures. It has been viewed as a good way of managing exponential growth concepts. In the world of finance, it is used to measure the potential rate of growth for investments.
All the same, the estimate is not an exact or precise one. But it helps a great deal specifically when dealing with exponential growth and also compound interest.
The estimate is better applied to instances where there is steady growth that extends over a long term horizon. A classic example is the rate of population growth over time.
However, where there are variations of the growth rate, the rule does not apply well.
In the case of negative growth, the rule of 70 can also apply.
The rule of 70 can also be used to estimate when a country’s currency is likely to halve in term of purchasing power. The rate that will be used in this case is the rate of inflation. For example, when the rate of inflation in a particular country is at 3%, the calculation will be 70/3=23.4. Therefore, we can estimate that the currency of that particular country will halve in terms of its purchasing power in about 23 years.
In instances where one wants to estimate how many years it would take for a country’s economy to reduce to half, the rule of 70 can be used to estimate this period. If the growth rate is say -2% per annum, then the calculation would be 70/2=35. Thus, it can be estimated that the economy of the country will reduce to half the size it is at present in about 35 years.
Hence, it can be seen that the rule of 70 applies in many contexts other than economic growth. It can be even used in biology to estimate the duration it would take for bacteria in a certain sample to double. Its application is indeed wide.
Rule 69 and 72 May Apply
When mentioning the rule of 70, the rule of 69 and 72 must also be mentioned. There is not much of a difference in the application of the rule of 69 and 72. The only difference is that when calculating, you use 69 and 72 instead of 70.
The rule of 69 has been seen to be more accurate when there are processes that are continually being compounded. The rule of 72, on the other hand, is considered to be more accurate when the processes are compounded less frequently.
But all in all, all the rules perform the same function and are used to get the same estimate. The rule of 70 is only preferred because it is easier to recall and perhaps it is easier to calculate with.