Compound interest can be a difficult thing for your child to understand. The good news is that as long as your money and your child’s money is in a savings account, compound interest works (how cool is that?). Today’s Youth Month lesson is about the big impact starting small has on your savings!
So, how to explain compound interest to a child?
Compound interest is one lesson that doesn’t get exciting until you start to see BIG results. Yet, if we wait too long to discuss this lesson, getting to the point of saving enough money to make compound interest exciting is difficult.
Let’s be honest here; no kid is excited about earning $0.01 and $0.015 due to compound interest. (It’s even hard to be excited about it as an adult!)
But before we create excitement around the potential our money has – we need to talk some basic principles.
How to Explain Compound Interest – Basics First
First up, we need to understand interest at the most basic level.
When you deposit and keep money in your credit union savings account, your money earns its own money, which is called interest. Your credit union pays you this interest to thank you for trusting us with your money! (Pretty sweet, right?)
The interest earned is added into your savings account total – which you get to keep! That new total (what you deposited + what you gained) then makes more money, which is called compound interest.
Multiplication is Where It’s At
Here’s another angle to try:
- Addition: You can add money into an account (from babysitting, birthday money, allowance, chore commissions, etc.). But without any interest, your balance remains the same! It only increases when you deposit more into the account.
- Multiplication: When you deposit into an interest-earning savings account, the interest gives your money a boost! It multiplies your money, even when you don’t make deposits.
The more often you multiply something, the higher your overall earnings. When we talk about compounding monthly or daily, we’re talking about how often the multiplication gets to happen.
- Compounded Monthly: Interest earned increases the original total once a month. So, once per month, your initial amount grows.
- Compounded Daily: The interest is added to the total every day. Each day, the total money that earns interest is growing.
Interest grows each day of the month, regardless of when compounding occurs. Monthly and daily simply tells you when you’ll see that interest added to your savings.
Today’s Compound Interest Activity!
One of the toughest things about preparing for the future, especially for your little ones, is patience and understanding of who they’ll be in the future and what their needs are.
Here’s a fun way for your child to see an older version of themselves. By utilizing an age progression app, your kiddo gets a clearer understanding of time as it relates to them and how their money also has the opportunity for change over time.
And if nothing else? You’ll both get a good laugh out of it! Or they’ll be shocked at seeing themselves older than they are. Either way, you’ve caught their attention!
Here is a free age progression webpage! (Though, there are plenty of apps in the app store too if you find one you like better!) You can age the photo by 20 years, or by 30 years.
Next, you want to show your child how much money opportunity there is for their savings account to grow, based on their savings commitment.
Use this free compound interest calculator, and start by plugging in these numbers:
- Initial Investment: $100
- Contribute Per Month: $10
- Length of Time in Years You’ll Contribute: Put in either the 20 or 30 years you chose in the aging image app.
- Interest Rate: 2.5%
- Compounded: Let your child play with the four choices — annually, semi-annually, monthly, and daily.
When finished, click the “show table” button. You’ll see the total contributions, and how much their money earns over the years. So, at a $10/month deposit, your child will contribute $2,500 over 20 years. BUT, their money will make an additional $829.22 through compound interest, for a total of $3,229.22, 20 years from now! Use this calculator to try different contributions and allow your child to dream big! When they see the possibilities, they’ll be amazed at all they can accomplish!
So we’ll ask again, would you rather have $1,000,000 now or 1 penny that doubles itself for a month? Has your answer changed?
You can find that worksheet here!
Don’t forget to participate in our #AltanaSavingsChallenge! Get your young saver started on their financial journey by making a $5 deposit into their savings account! We’ll enter them for a chance to win a $50 deposit!