How to Spot What's too Good to Be True: The Rule of 72

You may have heard the saying 'If it sounds too good to be true, it probably isn't true'. But how do you work out what is too good to be true?

Start with the rate of return you have been offered. Most investments illustrate their rates of return using percentages. While that's reasonable, research suggests that many people have trouble working out percentages, especially in their heads.

Use the Rule of 72

One way to tackle this problem is to work out how long it would take to double the money you originally invested if you reinvested all your returns. This is simpler than it seems. Before calculators or spreadsheets, investors used the old 'Rule of 72'.

How the Rule of 72 works

Suppose you were offered an investment with a return of 10% per year and you reinvested all your returns. How many years would it take to double the value of your original investment? The Rule of 72 says that you divide 72 by the annual rate of return to get the number of years it will take to double your money. So for 10% per year:

72 divided by 10 = 7.2

which means that at this rate of return, it will take a bit over 7 years to double the value your original investment. If you get a 20% per year return, it will take over 3½ years to double your money. If you get only 3% per year you will have to wait 24 years.

The Rule of 72 is not absolutely precise, but it gives you a practical estimate that you can work out in your head.

Who wouldn't want to be a millionaire?

Before you start dreaming of a very high return, ask yourself this: Could you safely and seriously expect to make that much money that quickly? Remember, you're probably not the only person investing in the scheme. If you are getting unbelievable returns, so are all the other investors. Just think — if 3,000 people each put in $10,000 (and many people put in much more), then everyone would be a millionaire after 10 years. The whole scheme would be worth $3 billion. Common sense should tell you that something about these numbers just isn't right.

By Australian Securities and Investment Commission


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