The Power of Compound Interest for Kids

Albert Einstein reportedly called compound interest the "eighth wonder of the world," saying, "He who understands it, earns it; he who doesn't, pays it." Teaching children about this powerful financial concept early can set them on a path to financial success. Discover why financial literacy matters for kids and understand the importance of early money education. In this newsletter, we'll explore how to explain compound interest to children in simple terms and why starting early can make a huge difference in their financial future. Explore more financial literacy activities for kids on our blog.

What is Compound Interest?

Compound interest is when you earn interest not just on your initial investment, but also on the interest you've already earned. It's like a snowball rolling down a hill, getting bigger and bigger as it collects more snow. The longer the snowball rolls, the larger it becomes.

Simple Explanations for Kids

Here are some age-appropriate ways to explain compound interest to children:

• The Magic Penny Explanation: Ask your child if they would rather have $1 million right now or a penny that doubles every day for 30 days. Most children will choose the million dollars, but the doubling penny would give them over $5 million by day 30!
• The Growing Garden Analogy: Compare money in an interest-bearing account to planting seeds in a garden. Not only do the original seeds grow into plants, but those plants produce more seeds, which grow into even more plants.
• The Snowball Effect: Describe how a small snowball gets bigger and bigger as it rolls down a hill, collecting more snow along the way. Money with compound interest works the same way.

Why Starting Early Matters

One of the most important lessons about compound interest is that time is a crucial factor. The earlier you start, the more powerful the effect. Here's an example you can share with your children:

Imagine two friends, Early Emma and Late Larry:

• Emma starts investing $1,000 per year at age 10 and stops at age 18, investing a total of $8,000.
• Larry starts investing $1,000 per year at age 18 and continues until age 65, investing a total of $47,000.

Assuming both earn 7% annual returns, by age 65, Emma will have more money than Larry, despite investing much less, simply because she started earlier and gave her money more time to compound.

Fun Activities to Teach Compound Interest

Beyond explanations, hands-on activities can help children grasp this concept:

• Savings Chart: Create a visual chart showing how money grows over time with compound interest. Update it monthly to show real progress.
• Interest Game: Give your child a small amount of "interest" on their allowance if they save it rather than spend it. Increase the interest rate for longer-term savings.
• Savings Challenge: Challenge your child to save a certain amount and match their savings (essentially giving them an immediate 100% return).

Books and Resources

Consider these resources to further explain compound interest to your children:

• "The Compound Effect" by Darren Hardy (adapted for children)
• "One Grain of Rice" - A mathematical folktale that illustrates exponential growth
• Online games like "Financial Football" or "Peter Pig's Money Counter"

Remember, teaching compound interest isn't just about numbers and calculations. It's about instilling a mindset of patience, delayed gratification, and long-term thinking. These are valuable life skills that extend far beyond financial literacy. Get comprehensive financial literacy for kids guide with more investing concepts, or read about setting financial goals with your children to complement your investing education.

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