As parents, we want to teach our children about money so that they can grow up to be financially savvy adults. But let’s face it – money can be a tough subject to tackle, especially with young children. However, I believe that it’s never too early to start teaching kids about the basics of personal finance, including the power of compound interest.
Recently, I sat down with my 6-year-old to teach him about compound interest. To my surprise, he was actually excited to learn about it – even at 6:30am on a Sunday morning!
Here’s what I taught him, and how you can teach your own child about the power of compound interest.
What is Compound Interest?
First, we emptied out Mr 6’s piggy bank onto the coffee table and added up all the coins and notes he had. He had saved $50 from birthdays, the tooth fairy and small jobs around the house that he’d helped with.
We entered $50 into an Excel spreadsheet and I started to explain what interest is.
I told Mr 6 that when you put your money in a bank account, the bank pays you a little bit of extra money for keeping your money there (because they can then lend that money out to someone else). This is called interest.
Then, I introduced the concept of compound interest. I told him that when you earn interest on your money, that interest gets added to your original amount of money. And then, the next time you earn interest, it’s based on the new, bigger amount of money – not just the original amount.
This means that your money can grow faster and faster over time, because you’re earning interest on top of interest. That’s the power of compound interest!
Using Real-Life Examples
Next, I wanted to show my son some real-life examples of compound interest, so he could understand it better. I went back to my Excel spreadsheet and showed him how much his savings account would grow over time with and without compound interest.
For example, let’s say his $50 was in a savings account, and he earned 5% interest per year.
After one year, he would have earned $2.50 in interest, for a total of $52.50. But with compound interest, he would earn interest not just on the $50 he originally had, but also on the $2.50 in interest he earned.
So in the second year, he would earn 5% interest on $52.50, which is $2.63. After two years, he would have a total of $55.13.
I also showed him how compound interest works over longer periods of time. For example, if he saved $100 a month for 10 years and earned 5% interest per year, he would have over $15,000 in his account at the end of the 10 years. But if he saved the same amount of money for the same amount of time, but didn’t earn any interest, he would only have $12,000 in his account. That’s the power of compound interest at work!
Making it Fun
To keep Mr 6 engaged, I plotted his age on the spreadsheet and showed how much he would need to save to get to $1,000. He wanted to know how much he needed to have to buy a house which I did show him but that’s possibly a little too mind blowing for a 6 year old!
Teaching Good Habits
Finally, I wanted to make sure my son learned good savings habits as well. I explained to him that the key to making compound interest work for you is to save regularly and consistently. The more money you save, and the longer you leave it invested, the more powerful compound interest becomes.
I also showed him how to set a savings goal and create a plan to achieve it. For example, if he wanted to save $100 for a hot wheels track, I showed him how to break it down into smaller, more manageable goals, like saving $10 a month.
By teaching your child about the power of compound interest, you’re giving them a valuable financial lesson that will serve them well throughout their lives. And who knows – maybe one day they’ll be able to teach it to their own children!
Opening a bank account
Once we’d finished having fun discussing the theory, we opened up a bank account and I immediately transferred the money into it from my account.
I kept the cash so that he could continue to do small jobs around the house and earn ‘real’ money which I would transfer into his account every week to earn more interest.
Who knew spreadsheets and money could be so much fun at 6:30am on a Sunday morning!