For investors who have grown their money through compounding, teaching their loved ones about this investment strategy is a must. By the time children start tackling sixth-grade math subjects, they should be ready to understand the basics of the compound interest formula, which you can explain with the help of any online calculator.
Explaining the Concept of Interest
The first concept you should explain is annual interest, and why it is paid daily into your account; to this effect, you can tell children that the daily earnings are nice rewards given by bankers to show appreciation for keeping your money with them. Tell your children that the interest is added at the end of the day so that the balance can grow and earn even more interest the next day, and so on.
Choose a realistic interest rate for this short and fun financial lesson. We will go with 1%, which we must divide by 365 days to get 0.0027 as the daily compound earnings. We will also choose $1 as the initial investment and $1 deposited every month. As for the investment horizon, we will choose five years because that is roughly when your children will be in their senior year of high school.
Compound Interest Savings for the Future
With the numbers above, the compound interest calculation will come up to around $65. From here on, you can play with the variables so that the monthly contribution is $2, which will increase the investment horizon to $124. At this point, you can start mentioning some of the cool stuff that they could get with such savings in their senior year, but you may as well tell them that contributing $5 each month is highly realistic, and it could bump their savings to $308 before they graduate high school.
start saving up now
The goal of this explanation should be to make your children aware of how much their future lives could change if they start saving up now. An even better way to enhance this financial lesson would be to inquire with your bank about opening a custodial savings account for kids, preferably one that offers compound interest as well as colorful account statements.