Money Foundations for Kids: Compound Interest

As a parent, you teach your children to take care of their physical and emotional health. It only makes sense to teach them to take care of their financial health as well. Whether you're saving or borrowing money, compound interest plays a significant part in your financial health.

Learning about compound interest instills kids with crucial life lessons regarding patience and delayed gratification. Albert Einstein said, "Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn't pays it." Once children understand compound interest, they may be more inclined to save their money, avoid credit card debt and become financially healthy adults.

Some people don't learn financial literacy until it's almost too late. It's how they end up with thousands of dollars worth of credit card debt or near retirement age without saving a penny. If children learn to manage money early in life, some of adulthood's worst financial mistakes could be avoided.

Compound interest money lessons should be relatable to children's lives. We've got exciting and fun ways to learn about compound interest that will stick with kids into adulthood.

Compound interest is the interest calculated on the initial principal of a deposit plus the accumulated interest from prior periods on a loan or deposit. It is also known as interest on interest. Compound interest will grow at a faster pace than simple interest, which is calculated on the principal amount only. It compounds on a schedule that could be daily, monthly, annually or even continuously.

This graph shows the effect that saving even $1,000 can have when compound interest is earned over several years.

Understanding compound interest is easy once you get the hang of it. If you put $10,000 in an account earning only 5% interest and left it alone, at the end of one year, you’d have over $500 of interest earnings. Leave it there another year, and you’ve just made $1,000 in interest. By the end of the third year, you’ve got over $1,600 just in interest.

When you put money in a compound interest-earning account and leave it alone, your money will grow. If you add more money, then you’re really making your money work for you. Because now you’re not only earning interest on the original amount, you’re earning interest on your interest. It’s almost like magic!

You can teach children about compound interest in entertaining and lively ways, depending on their age. It can be a hard concept to grasp, but with visual aids and by using toys they already know and love, you can get this concept across to them in a way that will stick with them.

Ages: 4–11
Supplies:

• Bank printable
• Bag of candy: M&Ms, Skittle, gummy bears, mini marshmallows or other favorite treat.
• Tape or glue stick
• Crayons, paint, stickers and other art supplies

Ages: 8–13
Supplies:

• Label printables "Compound Interest" and "Interest-Free"
• Two large jars
• 78 quarters or other denomination of coins

Ages: 13-18
Supplies:

• Double the Penny Challenge Worksheet and Label Printable
• $81.92 in various denominations
• Empty Jar

While it’s entertaining for kids to play games to learn how compound interest works in their lives, it can also be fun for them to see how the numbers look when they are plugged into a calculator. This exercise can also be eye-opening for parents as well.

Parents can teach kids about saving money and investing as soon as children understand how money works. For example, children may know that they can use their $10 birthday money to buy a Fortnite T-shirt or some of their favorite candy bars. By showing children the power of savings early, this value will be instilled in children for the rest of their lives. With these methods, parents can encourage saving instead of spending.

When Anisa Kurji, podcast host of Kids Money and More wanted to teach her kids about how to save, she used a three-jar system with jars labeled "spend," "save" and "donate." Initially, the "save" jar money didn't have much meaning to the kids as it was going to their bank account," she said. "It was a black hole that they didn't know if or when they'd see that money again."

So, she changed the purpose of the money to saving for a specific goal. They'd have to be patient and not spend the money until they reached their goal. She said they were instantly motivated to add more to their jar and not spend it the same day they got it. "After awhile, I'll encourage them to put money aside for longer-term savings and investing. But for their first few goals, it shouldn't take too long to achieve, or children will lose interest in saving."

One day, financial coach Larry Duffany's son asked his parents for the newest electronic game. Instead of giving him the game, Duffany said they set up a savings thermometer. As his son was saving his money, he colored in the chart on the thermometer to see his progress. "Visual cues are important for younger learners," said Duffany. "He used this tracking chart to measure his progress and very quickly worked his way to that goal."

Monopoly is an excellent tool for teaching older children about money. One rainy afternoon, set up the game and see how fast your children learn lessons about saving and spending. They'll learn that if you are patient and use money as a tool to make more money, you'll come out ahead.

“A game like Monopoly illustrates the power of putting money to work,” said Brian McEvoy, senior vice president and senior retail banking officer at Webster Five. “Kids learn that if they own a property, anyone landing on it has to pay, and the more you invest in that property by putting houses or hotels on it, the more you get in return.”

When you're out and about with your children or shopping online, show them how to read prices. For example, if you're in the grocery store, and they insist on Cheerios, point out how the generic version of Cheerios is cheaper. Tell them if they settle on the generic version, they can save the difference and put it toward a new toy or game they want instead.

"(Ask) your kids to search for the cheapest option available online (or in-store) whenever they see something they like," said Freya Kuka, a personal finance expert and founder of the personal finance blog Collecting Cents. "This helps your kids contribute to the family's economic wellbeing while also taking some of the load of your back."

Abraham said that a straightforward option is to add interest to your child's piggy bank whenever they save their money in it for a month. "Showing them that by delaying their gratification, they can increase their rewards can be made educational, fun and rewarding."

Still need more ideas for educating children about money? Additional resources for teaching kids about finances and compound interest include:

• A Financial Literacy Handbook for All Life Stages: This MoneyGeek guide provides insightful resources and helps you establish good financial habits at all stages of your life. You'll find information on understanding your paycheck, student loans, buying a car on credit, understanding home loans and saving for retirement.
• Financial Peace Junior: This kit from Dave Ramsey comes with fun stories and activities that teach children about money, work, giving, saving and spending their money in smart ways.
• Foundations in Personal Finance: Another valuable Dave Ramsey resource is Foundations in Personal Finance, software that teaches teenagers financial literacy and essential topics such as saving and budgeting.
• Greenlight: Greenlight is a debit card for kids that parents can monitor. Parents can put kids' allowance on autopilot and create in-app chore lists while tying the work to perks.
• How to Identify and Address Financial Child Abuse: This MoneyGeek guide provides crucial information on recognizing the signs of financial abuse in children and offers steps to address and prevent it.
• Kiddie Kredit: Kiddie Kredit is an app kids can use to track their chores and show them how to use their money wisely.
• Kids Money and More: This podcast teaches kids about a new financial topic, including coming up with basic budgets and making SMART money goals.
• Finance For Kidz: Finance for Kidz is a set of books covering the basic topics of finances presented in an engaging manner, so as to get kids interested in various aspects of finance.