Question

As the compounding period grows shorter, does the rule of 72 become more or less accurate?

A) More accurate
B) Less accurate
C) Equally accurate
D) It's not clear

Answer 1

The rule of 72 becomes less accurate as the compounding period grows shorter because it does not fully account for the effects of more frequent compounding. It is best suited for annual compounding or when the interest rate is low.

Step-by-step explanation:

Regarding the accuracy of the rule of 72, as the compounding period grows shorter, the rule tends to become less accurate. The rule of 72 is a simple formula used to estimate the number of years required to double the invested money at a given annual fixed interest rate. By dividing 72 by the interest rate, you get an approximate number of years.

For investments with continual compounding interest, this rule is not as precise because it does not account for the effects of compounding more frequently than annually. As such, when compounding occurs quarterly, monthly, or daily, the rule of 72 overestimates the time needed to double the investment. It is more tailored to situations where compounding happens annually or the interest rate is low and the compounding frequency does not considerably alter the outcome.

Investors or students might still use the rule for quick estimates, but they should be aware of its limitations for shorter compounding periods and rely on more accurate formulas for exact figures.