By: Scott Van Den Berg, CFP®, ChFC®, CEPA®, AIR®, CRPS®, CMFC®, AWMA®
Explaining compound interest to your kids or grandkids is a great way to introduce them to the concept of saving and investing. Here are some thoughts on how you can explain it in a simple and understandable way:
1. Start with the basics:
- "Today, I want to talk to you about something really cool called 'compound interest.' It's a way to make your money grow over time. It’s a way your money can work for you!"
2. Define compound interest:
- Compound interest is like a magic trick for your money. When you save or invest your money, the bank or investment grows your money not just on the original amount you put in, but also on the interest or gains it earns over time.
3. Use examples:
- "Imagine you have $100, and you put it in a savings account that pays you 5% interest every year. At the end of the first year, you'll have $105 because you earned $5 in interest.
- But here's the cool part, in the second year, you'll earn interest not just on your $100, but also on that $5 you earned last year.
- This means at the end of year two, if you earn 5% interest on the starting value of $105, you will finish the year with $110.25 in your account. And so on!"
4. Emphasize the power of time:
- "The longer you leave your money to grow with compound interest, the more it grows. That's why it's important to start saving and investing early."
- Financially speaking, I believe starting a savings and investing plan early in life is the single best financial decision one can make. While your kids or grandkids can choose different investments and savings amounts over their lifetime, nothing will truly replace the opportunity of “more time to compound and growth their money” than starting this plan while they are young.
- For example, the table below shows the value of a $1,000 deposit made each year that has an average annual growth rate of 10%.
|This example is for illustrative purposes only and does not guarantee success or a certain level of performance. It does not include fees or taxes, and it is not adjusted for inflation. Numbers have been rounded.|
5. Relate it to their goals:
- "Compound interest can help you save up for things you want, like a new bike, a computer or cell phone, maybe a car, a college or trade school education, and someday a home, and eventually retirement. The more you save and the longer you patiently let your money grow and work for you, the more money you'll have in your golden years."
6. Encourage saving:
- "Wouldn't it be great to watch your money grow? You can start by saving a portion of your allowance or any money you receive as a gift or from jobs you do around the neighborhood.
- When you are old enough, you might even have a summer job at one of the stores or restaurants nearby.
- We can open a savings or brokerage account for you, and you'll see how your money grows over time."
- As parents or grandparents, I also suggest if your kids or grandkids do save money and make deposits into this new account, you might consider some sort of matching contribution. This will help them grow their balance even faster, which in turn can really help add to the motivation to keep up this savings and investment plan.
7. Keep it simple and age-appropriate:
- Be sure to tailor your explanation and examples to your child's age and comprehension level. Use simple language and repeat the concept over time to reinforce their understanding.
8. Use real-world examples:
- Show them how compound interest works. For a fun example, ask them the following: “Would you rather have $1 million today, or a penny that doubled every day for 30 days. The answer is likely to get a smile from your kids, and probably you too!
9. Be patient and answer questions:
- Let your child ask questions and be patient in addressing their curiosities. Encourage them to explore the concept further as they grow older.
10. Set a good example:
- Children learn a lot by observing their parents, so be a role model for responsible saving and investing practices.
By introducing your kids to the concept of compound interest early, you can help them develop good financial habits and set them on a path toward financial literacy and success in the future.
The exciting part is that with such long time horizons (i.e., 40+ years to save until their retirement age), irrespective of their education, future job choice, or any other savings or investments they may make over their lifetime, relatively small amounts of annual savings that range from $2,500 to $5,000, can give your kids a real chance to become millionaires, and some even multi-millionaires in their retirement years.
To learn more on how to talk to your kids about money, contact our team of dedicated Certified Financial Planners at Century Management.
Century Management ("CM") is an independently registered investment adviser with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. CM is also registered as a Portfolio Manager in the Province of Ontario. All investments carry risks. Past performance is not indicative of future results. This discussion is not intended to be investment advice and does not take into account specific client investment objectives. A full description of our Firm’s business practices, including our Firm’s investment management services, wealth plans and advisory fees, are supplied in our Form ADV Part 2A and/or Form CRS. These Forms are available upon request by calling 512-329-0050 and are also on our website at centman.com. CM-2023-10-06