# How to Teach Kids About Compound Interest

Three Methods:Using the Dollar MethodHelping Your Child Understand What Interest IsTeaching the Concept of Compound Interest

If you have a child who is old enough to do basic math, then teaching them about why compounding interest is important for them is a great idea. A topic like this can be difficult to understand without seeing it in action. You can use the penny method to teach your children about how interest works, and the dollar method to demonstrate compound interest. Take time to understand compound interest and why it is important.

## Steps

### Method 1 Using the Dollar Method

- 1
**Put one dollar in a jar.**Keep this jar in a place where it can be easily seen. Add $1.00 to the jar, and explain that you will help them to add 10% interest to what is in the jar every single day for a week.^{[1]}- You can do this for longer if you want. A week should be enough time to show your child how compound interest works.
- Keeping the jar in a place where it is in view will keep you both from forgetting about the project.

- 2
**Add 10% interest to the contents of the jar each day.**On the first day, you will have $1.00 in the jar, so ask your child to help you figure out what 10% of $1.00 is. Once they tell you that 10% of $1.00 is 10 cents, add a dime to the jar. Ask them to tell you what the new total is. Keeping the interest figure low will present a more realistic idea of what your child could expect to earn from a bank. If you want to, you can also use higher interest rates.^{[2]}- On each of the following days you will repeat this process. Have your child count the contents of the jar, and ask them to help you calculate 10% of the total contents of the jar.
- For example, on the second day the new total is $1.10 and 10% of this is 11 cents, so you should add 11 cents to the jar.
- The third day you now have $1.21 and 10% of that is 12 cents.
- On the fourth day, you will have a new total of $1.33, and 10% of that is 13 cents, so you should add 13 cents to the jar.
- On the fifth day, your new total will be $1.46. 10% of $1.46 is 15 cents (it’s actually 14.6, but you should round up to 15 in this case). Thus, you should add 15 cents to the jar.
- On the sixth day, your new total is $1.61. 10% of that is 16, so add another 16 cents to the jar.
- On the last day, you will have a total of $1.77 in the jar. 10% of this is 18, so you add the final amount of 18 cents to the jar. In total, your child will have saved $1.95.

- 3
**Help your child add up the new total.**On the eighth day, you and your child can now take down the jar and count up the new total. Be sure to point out that your child has saved up almost 100% of what they put in the jar in the first place.^{[3]}- Explain to your child that this is a good way to grow their money.

### Method 2 Helping Your Child Understand What Interest Is

- 1
**Begin by giving your child a bag of pennies.**It doesn’t have to be a huge number of pennies. A small bag with a handful of pennies will be more than enough. Explain that you are going to teach them about something called interest.^{[4]}- Understand that this method doesn’t demonstrate compound interest. The point of this method is to show kids what interest is. Show this to your child first if they are struggling to understand interest.

- 2
**Ask them to deposit one penny into the bank.**On the first day, ask them to deposit one penny into the bank, and tell them that you are their personal banker. When they give you a penny, place it in a container that is their “bank account.”^{[5]}- If your child doesn’t know about how banks work, be sure to explain what a bank is. Explain that a bank is a place where you can keep your money safe, and that when you put your money in the bank you are agreeing to let the bank use your money, but it will all be there when you need it.

- 3
**Write them a receipt for the “deposit.**” After they give you a penny, write them a receipt that includes how much money they have given you (in this case, 1 cent).^{[6]}- Explain to them that it is important to keep these receipts in a safe place so that they have proof that they have put that money into the “bank.”

- 4
**Teach your child how to check their bank account.**Explain how to find out how much money is in their bank account. In this case, explain that all they have to do is ask you.^{[7]}- If you haven’t already taught your child about ATMs, this is a good way to give them an idea of how they work. Be sure to explain that, unlike banks, you can use an ATM at any time of the day or night.

- 5
**Add extra pennies to your child’s bank account.**Every other day, add a penny to your child’s bank account. This will be the interest that your child is accruing.^{[8]}- You could also add an extra penny every day. Be aware that this could create unrealistic expectations about how much money they can earn through interest.

- 6
**Show them how much money they have accrued.**At the end of one week (or however many weeks you want to do this demonstration), ask your child to check their balance. Ask them to check their receipts to figure out how much money they have put into the bank. When they do this, then dump out the pennies, and ask them to count the pennies. Explain that the extra pennies are interest that they've earned.^{[9]}- Explain that the original seven pennies have grown to eleven pennies (assuming you added one penny every other day) because the bank paid a penny of it’s own into the account as a thank you for allowing them to use your child’s money.

### Method 3 Teaching the Concept of Compound Interest

- 1
**Explain why banks might pay compound interest.**When thinking about why a bank should give you money when they are the ones keeping track of your money for you, it is important to remember that you are giving the bank a loan. When you deposit money into the bank the bank is then using your money for its own purposes. Thus, they pay interest to you as a way of thanking you for the loan.^{[10]}- Usually, the bank uses your money to make loans to other bank customers. The bank makes money on this by charging higher interest fees on the loans than what they are paying you in interest.
^{[11]}

- Usually, the bank uses your money to make loans to other bank customers. The bank makes money on this by charging higher interest fees on the loans than what they are paying you in interest.
- 2
**Talk about what makes compound interest especially valuable.**Not all accounts will offer compound interest specifically. Compound interest is a great thing because not only does it pay interest on what you put in the account (this is called the principal), it also pays interest on the interest it paid you last time.^{[12]}- This makes your money grow faster than if they just paid you interest on the amount you put in the bank and left the extra interest money out of the equation.

- 3
**Help children understand why they should care about compound interest.**In the society we live in, it’s important for children to learn why it’s important to save money, and how they can do it most effectively. If you give your children an allowance, teaching them to save part of that allowance rather than running to the store to blow it all at once can create good spending habits that will follow them throughout their life.^{[13]}- When teaching children about compound interest, make sure that you begin the discussion by talking about what interest is in the first place.
- For example, you can say something like, “When you have a bank account, they do their best to keep your money safe. At the same time, though, they take your money and lend it to other people who need it. As a way of saying thank you, banks usually pay you a little bit of money. This is usually a percentage, say 5%. They pay you 5% of whatever you’ve got in your account. So if you have $500 dollars, they pay you an extra $25 just because they appreciate you keeping your money with them.”

## Tips

- Teaching kids the importance of good spending habits early on will help them manage their money when they get older.

## Warnings

- While it may be good to use very high-interest rates for demonstration purposes, be sure to explain that banks usually offer much lower rates. It is still good to take advantage of compound interest, but be realistic about what they can expect.

## Sources and Citations

- ↑ http://www.consumerfinance.gov/askcfpb/1683/i-want-teach-my-11-year-old-about-compound-interest-there-easy-way-illustrate-it.html
- ↑ http://www.consumerfinance.gov/askcfpb/1683/i-want-teach-my-11-year-old-about-compound-interest-there-easy-way-illustrate-it.html
- ↑ http://www.consumerfinance.gov/askcfpb/1683/i-want-teach-my-11-year-old-about-compound-interest-there-easy-way-illustrate-it.html
- ↑ http://www.frugaldad.com/how-to-teach-compounding-interest-to-kids/
- ↑ http://www.frugaldad.com/how-to-teach-compounding-interest-to-kids/
- ↑ http://www.frugaldad.com/how-to-teach-compounding-interest-to-kids/
- ↑ http://www.frugaldad.com/how-to-teach-compounding-interest-to-kids/
- ↑ http://www.frugaldad.com/how-to-teach-compounding-interest-to-kids/
- ↑ http://www.frugaldad.com/how-to-teach-compounding-interest-to-kids/
- ↑ http://www.money-rates.com/ask-the-expert/why-banks-pay-interest.htm
- ↑ http://themoneycharity.org.uk/advice-information/bank-money/
- ↑ http://www.investopedia.com/terms/c/compoundinterest.asp
- ↑ http://www.itsahabit.com/interest.html

## Article Info

Categories: Banking