S&P 500 Index vs. Deposit: What happens to 100,000 shekels in a decade?
An average historical return of 10.3% versus a 3% interest rate creates a huge gap, but a whole decade in history ended in the negative.
100,000 shekels at a 3% interest rate reach about 134,000 shekels after ten years before taxes. The same 100,000 shekels at an annual return of 7% reach about 197,000 shekels, and at a return of 8% to about 216,000. The gap between the two scenarios is about 63,000 shekels, and this is the result of compound interest on the same initial amount. The numbers are correct as long as the return is indeed received throughout the period and the money remains invested until the end.
The S&P 500 index has yielded an average annual return of about 10.3% since 1957, including dividends. After inflation, this is about 6% to 7% per year. This average is composed of years of double-digit gains and years of collapse: the index lost 37% in 2008, fell about 49% from the peak during the tech bubble burst, and fell about 57% from the peak during the financial crisis. A one-year bank deposit did not fall in any of these years.
The index includes 500 of the largest companies traded in the USA and represents the large part of the US stock market value. It is market-cap weighted, so large companies get a high weight and the index is particularly sensitive to the technology sector. Buying it is a decision on one market, one currency, and a specific sector mix, not full global diversification.
The gap between average and result
One decade illustrates the gap between average and result. In the ten years that ended at the end of 2009, the index yielded an annual return of minus 0.95%, meaning 100,000 shekels became about 91,000 shekels in dollar terms before taxes. On the other hand, out of 978 rolling ten-year periods since 1928, about 93% ended with a positive return, and on a fifteen-year horizon, the rate approaches 100%.
The dollar changes the result for an Israeli investor. The dollar exchange rate fell by about 11% in the last year and stands at about 2.99 shekels, after trading in the range of 2.80 to 3.42 shekels in the last 52 weeks. The index itself rose by about 21% in the same period, and an Israeli investor who held a currency-exposed track ended it with about 7.6% in shekels instead of the full dollar return. In a year when the dollar strengthens, the mechanism works in his favor with exactly the same intensity. A currency-hedged track removes this exposure at a price. The cost of hedging is derived from the interest rate gap between the shekel and the dollar and appears as a current deduction from the return, so it is not free.
Taxation and real return
The tax reduces the gap and it is still large. A 15% tax applies to interest on a non-linked shekel deposit, and a 25% tax applies to real capital gains on securities. On a 3% deposit for a decade, the nominal profit is about 34,000 shekels and the tax is about 5,200 shekels, meaning about 129,000 shekels net. In an investment that yields 7% per year, the amount reaches about 197,000 shekels, and at an inflation of 1.6%, the adjusted principal stands at about 117,000 shekels. The taxable real profit is about 79,000 shekels, the tax is about 20,000 shekels, and the net result is about 177,000 shekels.
A point that usually stays under the radar concerns the deposit side. The tax there is collected from the full nominal interest, including the part that only compensates for price increases. At a 3% deposit and 1.6% inflation, the real return before tax is about 1.4%, and the tax deducts about 0.44 percentage points from it. In real terms, this is a share of about a third of the real profit instead of 15%, and as inflation climbs, the share grows: at 2.5% inflation, the same tax swallows almost all the real profit. In index-linked instruments, the rule is the opposite. There, the tax is imposed only on the real profit, and the linkage component that compensates for inflation is outside the tax base. This is the explanation for why an asset with a lower stated return sometimes ends up with more money in hand, and in a high-inflation environment, this gap widens.
Investment horizon and risk management
The investment horizon determines more than any forecast. A person who designates 100,000 shekels for a down payment on an apartment in two years and a 35-year-old person who designates them for retirement hold the same amount and two different problems. The first needs availability and preservation of the principal, and a 20% drop in the wrong year cancels the deal for him. The second can absorb three weak years and let time work. This difference is more decisive than any forecast for the coming year.
A deposit is not risk-free, it just replaces a type of risk. A 3% interest rate at 1.6% inflation leaves about 1.4% real before tax and about 1% after it, so purchasing power grows very slowly. Anyone who leaves an amount for twenty years in such a product pays for nominal stability with real growth that did not happen, and this is a risk that is difficult to identify because it does not appear as a decline on the account statement.
The full article was originally published on Bizportal.
