Can you imagine doubling $10,000 to $20,000? Or perhaps you have a nest egg of $500,000 and want to double it to $1 million? No matter where you are in your financial journey, you can benefit from doubling your money.
To grow your money, you earn a rate of return from it. The return is calculated for every year. For example, if you save in a GIC or CD (depending if you’re in Canada or the U.S.), you earn a fixed rate of say 2% every year. So, if you place $1,000 in a GIC or CD, you’ll get $1,020 a year later. $1,000 was your principal and $20 was the interest you earned.
It doesn’t always work that way because instead of a maturity of one year, a GIC can mature in 3 months, 6 months, 9 months, 1.5 years, 2 years, 3 years, or 5 years. Your money is parked for that duration and you are guaranteed to retrieve your principal and interest.
You might notice that a 2% rate of return is too low for you to meet your goals. So, you turn to the stock market for higher returns. In contrary to what some would believe, the stock market is not a casino and it can be a safe way to double your money (and double your money again and again) if you know what to look for and what to expect.
First, let’s look at what contributes to total returns.
Total Returns = Capital Appreciation + Dividends
When you own a piece of a company by buying shares of it in the stock market, you’ll experience stock prices going up and down due to market sentiment in the short term and due to company fundamentals in the long term.
If in the short-term, there’s bad news for a company, the price of a stock would fall. Likewise, if there’s good news, the company’s price would rise. However, over the long term, if a company continues to post higher profits, it’ll become more valuable and its share price will eventually rise.
Johnson & Johnson (NYSE:JNJ) continues to grow its earnings year after year (as illustrated by the rising orange earnings per share (EPS) line), yet you can see its price (black line) going up and down. Its price eventually follows the earnings by returning to the orange line.
Investors can very well sell their J&J shares for a gain as a part of their returns. However, J&J also pays a growing dividend. So, the healthcare juggernaut rewards shareholders by returning some profits to them via dividends.
If you invested $1,000 in J&J today, how long would it take to double?
Rule of 72
This is where the Rule of 72 comes in. It’s a simple way to approximate how long it’d take to double your money using the rate of return you expect from your investments.
J&J yields 2.6% and is expected to grow its EPS by 6% in the medium term. This implies a return of roughly 8.6% per year. Let’s be conservative and call that 8%.
Using the Rule of 72, we approximate:
72 / 8% = 9 years
So, it’ll take about 9 years for an investment in J&J today to double.
Does it mean the higher the return, the faster your money doubles?
Wait a minute! Can’t we just look for the highest growth companies, invest in them, and double our money quicker?
Let’s take a look at Facebook Inc (NASDAQ:FB). From 2012 to 2015, it increased its EPS from US$0.53 to US$2.28, which is a compound annual growth rate of 62%. In the same period, Facebook delivered returns of 58% per year, which equates to a total return of more than 290%!
Using 58% as the rate of return in the Rule of 72 formula, Facebook investors would have doubled their money in about one year and 3 months!
Why doesn’t everyone just flock to Facebook then? Well, they sort of have. At about US$123 per share, Facebook trades at a whopping price-to-earnings ratio (P/E) of 37x. This is more expensive than most stocks on the market.
Arguably, though, Facebook is expected to grow its EPS by about 35% per year in the medium term. So, the high multiple may be warranted.
The tricky part is that no company can continue growing at a super high rate forever. So, investors should be careful with the number they plug into the Rule of 72.
How to use the Rule of 72 Properly
Be conservative with the rate of returns you expect.
Use it for individual stocks and for your diversified portfolio, so that you can approximate how long it’ll take your portfolio to double. So, for your portfolio’s expected rate of return, you’ll use the expected weighted average rate of return based on your portfolio constituents.
Let’s say you have $5,000 of J&J and $2,000 of Facebook. Your expected portfolio rate of return would be about 14% assuming you expect J&J to grow 8% and Facebook to grow 30% every year going forward.
($5,000 / $7,000) * 8% + ($2,000 / $7,000) * 30% = 14.2%
So, it should take a little over five years to double your money.
72 / 14% = 5.14 years
Of course, growth rates will change over time, so keep yourself updated.
Other factors to help you Double Your Money
We just learned that the higher the growth rate, the sooner your money doubles (all else being equal).
Buying at a lower valuation also lets you double your money sooner. The assumption is that you’re buying a company for less than it’s worth and that eventually the market will realize the opportunity and bid up the shares.
However, whenever you think a company is cheap, do think about the reasons causing it. If it’s a temporary issue that can be resolved over time, then, you probably got a deal. If you have any doubts, stick to quality companies with strong balance sheets and credit ratings (e.g. S&P credit rating of BBB+ or better).
Contributions are very important, especially if you are early in the accumulation stage. If you just started to invest this year, your contributions from your savings will make it or break it on whether you double, triple, or even quadruple your portfolio.
Let’s say you started your portfolio with $1,000 in Brookfield Property Partners LP (TSX:BPY.UN)(NYSE:BPY), which I think is a decent value today. The estimated rate of return is 10% (without accounting for its discounted valuation to be conservative).
So, an investment in BPY today will take at most 7.2 years to double. However, if you contribute another $1,000 within the next 12 months, you’ve already doubled your money (probably not in the sense you were thinking of, but you know what I mean). So, by the end of the year, you’ll have roughly $2,100 in your portfolio (assuming the 2nd batch of shares didn’t generate any dividends).
The Rule of 72 is a simple way to approximate how long it’d take to double your money using the rate of return you expect from your investments. The higher the return, the sooner your money doubles.
However, I would caution not to solely chase high growth because high-growth stocks will eventually slow down, at which time their multiples would contract and the shares might go sideways, or worse, fall.
If you can buy companies for less than they’re worth (i.e. at a discounted valuation), you’ll get higher expected returns. This is independent from the earnings growth of the company. This is talking about how much you pay for your shares – whether you pay too much, just right, or got a deal.
Early on in your investment career, a high savings rate will help you jumpstart your portfolio. Financial advisors would tell you to save at least 10% of your paycheque. However, some of my friends save up to 50%!
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.Disclosure: At the time of writing, I own shares in Facebook and TSX:BPY.UN.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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