Home Prices, Household Incomes, and the Rule of 72

Chart of the Week for May 27-June 3, 2005

The median sales price of previously owned homes has more than doubled since 1992. In comparison, the median household income has increased approximately 48% since that time. This divergence between median housing prices and median household incomes has led to vigorous debates among some of the top U.S. economists about the possible froth in the real estate market. While many will argue that we are experiencing a real estate bubble, others will argue that the supply-of-housing in relation to the demand-for-housing, constitutes the dramatic increase in housing prices. This debate is best left to the experts.

However, an important financial lesson can be gleaned from the chart above. Have you ever wondered what rate of return you would need to achieve in order to double your money in a set number of years? Have you ever wondered if there was an easy way to determine the number of years it would take to double your money assuming a set rate of return? Well, the answer lies in the Rule of 72.

The Rule of 72 is based on the quotient of 72 and your set rate of return or your set time horizon. For example, if you want to double your investment in eight years, you would need to experience a rate of return close to 9%. This estimate can be easily calculated by dividing 72 by eight. This process also works in reverse. For example, if you experience an annual rate of return of 9%, you will double your money in approximately eight years, as determined by dividing 72 by nine. The Rule of 72 is based on annual compounding and is very accurate for periods and rates between five and 15.

This illustration was compiled by information from outside sources. These companies are not affiliated with ICMA-RC. This information is being provided for educational purposes and is not intended to be construed as or relied upon as investment advice. ICMA-RC does not offer specific tax or legal advice. Individuals are advised to consider any new investment strategies carefully prior to implementing.

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