The Power of Compound Interest: How Small Savings Grow Exponentially Over Time
The principle of compound interest, where earnings generate further earnings, can significantly multiply savings over decades, especially when started at a young age. For instance, a NIS 100 note invested at an average annual return of 7% can grow to nearly NIS 1,000 in 34 years without any additional deposits. This effect is amplified by time; starting such savings at age 18 means accumulating almost NIS 1,000 by age 52, with the growth rate accelerating thereafter.
Compound interest differs from simple interest by calculating returns on both the initial principal and accumulated interest. While the difference is negligible in the early years, it becomes substantial over time. After ten years, NIS 1,000 at 7% yields NIS 129 annually, and by the thirtieth year, it generates NIS 498 annually, with the principal growing to NIS 7,612. A useful rule of thumb is the "Rule of 72," which estimates the number of years it takes for an investment to double by dividing 72 by the annual interest rate. At a 7% return, money doubles approximately every 10.3 years.
A table illustrating monthly NIS 200 deposits until age 67, assuming a 7% annual return before taxes and fees, highlights the impact of starting age. Beginning at 18 results in a total accumulation of NIS 938,000, while starting at 25 yields NIS 571,000, and starting at 45 leads to NIS 121,000. The seven-year difference between starting at 18 and 25, despite a smaller total deposit difference of NIS 16,800, accounts for a loss of approximately NIS 367,000 in final savings.
The article also contrasts the savings of two individuals, Noa and Daniel, to demonstrate this principle. Noa deposits NIS 200 monthly from age 18 for ten years, then stops. Daniel starts at age 28, depositing NIS 200 monthly until age 67. By age 67, Noa, having invested only a quarter of Daniel's total deposits, has NIS 479,000, while Daniel has NIS 460,000, due to Noa's early start allowing her funds nearly 39 additional years to grow.
Inflation works in the opposite direction, eroding purchasing power. A 2% annual inflation rate reduces the value of NIS 10,000 to NIS 8,200 over a decade, and a 3% rate reduces it to NIS 7,440. Currently, Israel's inflation is 1.5%, with the Bank of Israel's target range at 1-3%. Returns lower than inflation represent a real loss. The article distinguishes between saving (low risk, low return, for short-term needs) and investing (higher risk, higher potential return, for long-term goals). Management fees and capital gains tax can also significantly reduce returns; a 1% annual management fee can cost around NIS 265,000 over decades.
