The Rule of 72

This is a mathematical shortcut that is especially handy to investors seeking quick riches. Want to know how long it will take an investment to double in value? Simply divide 72 by the investment's assumed annualized return. For example, a mutual fund that returns 12% per year will double in value in six years; a fund that returns 18% per year will double in four.

Relevance for TIFF Members

We are providing this definition of the Rule of 72 because we sense that some may not appreciate fully an important corollary. The corollary is that the market's absolute direction can distort substantially a manager's skill in beating the market, as the following table indicates:

Annual Returns

As can be seen, our hypothetical manager could run a splashy ad at the end of the bull market scenario with line graphs depicting an attractive gap of 900 basis points between returns on its flagship mutual fund and the market's return over the preceding decade. The gap would be impressively large after just one year and would grow steadily thereafter. The gap would be equally large after just one year in the bear market scenario, of course, since the Year 1 returns are identical in the two scenarios. However, due to the market's dismal performance in Years 2-10, the gap would not grow beyond its magnitude at the end of Year 1, and the final figures would emphatically not be "such stuff as ads are made of." (Apologies to Shakespeare's The Tempest and to readers who frown on dangling modifiers.) Of course, one would not expect to find newspapers filled with mutual fund ads at the end of a long bear market, notwithstanding that a decade of poor returns would substantially improve the risk/return profile of stocks and stock mutual funds. Persons burdened with the unenviable task of selecting money managers (or mutual funds) should keep in mind a two-word legend that, if we ran the SEC, would mandatorily appear in bold face at the top of every mutual fund ad: Caveat emptor.