“My wealth has come from a combination of living in America, some lucky genes, and compound interest” – Warren Buffett
When one of the richest people on the Earth gives actionable advice that anyone can take it’s worth listening to. He’s used the magic of compound interest better than anyone.
Here are four fun ways to teach compound interest to kids:
Read A Book About Compound Interest
My third grader did a play at school called One Grain of Rice. We had read the book earlier this year.
One Grain of Rice is a lesson on how a grain of rice doubled every day for a month becomes a huge number – enough to bankrupt a kingdom. Substitute a penny for the grain of rice and there will be enough money to fill a mountain!
Read my One Grain of Rice article here. It has an interactive spreadsheet, which illustrates it better than a compound interest calculator in my opinion.
Give Kids Firsthand Experience
You can read books about fixing cars or programming computers. Reading is not the same as doing.
In The First National Bank of Dad (Review), I learned a technique where kids are given monthly interest payments on their deposits. Shorter compounding periods help kids notice the money growing faster. This creates an incentive to save more.
For example, a 3% monthly interest rate is an annual 42% interest rate. It’s something that many parents can do because kids don’t have $100,000 of principal to break the bank.
You may think that putting kids’ money in a traditional savings account is a great choice. However, the interest earnings are so low it will take them the rest of their lives to earn much. It’s no way to show how the rewards of compound interest are often described as the eighth wonder of the world.
Watch a Video About How Compound Interest Works
This video explains how the above works with a 10% monthly interest rate. It also illustrates how compound interest works over a lifetime:
While the video says it is geared to grades 5-8, I think it works for grade 3 and maybe even some second graders. The multiplication at the beginning is the most difficult part, but it’s very quick and kids don’t have to follow the math exactly to get it.
Take A Course MoneyTime is a course to teach kids about money in general. It covers much more than compound interest. MoneyTime has some gaming features like allowing kids to create their own avatar.
Teaching compound interest to kids is especially useful because they have more time to grow their money. The video above showed how much of a difference there is between an 18 and a 25-year-old saving over time. Imagine if you can start even seven years before the video’s example.
Last week my son’s third-grade class performed a school play, One Grain of Rice. We had read the book the previous summer as I had heard it was a great book that teaches math. Just check out the Amazon Reviews – have you seen anything so highly rated?
Before I explain the story, I will warn you that this article is going to contain spoilers. If you are a parent reading this hopefully you can live with a spoiled book for elementary-age kids.
The story of One Grain of Rice is simple. A humble peasant does a good deed for the ruling figure and asks for one grain of rice doubled every day for several weeks or a few months. I generalized that because my son’s school play version had some differences from the book version. The good deed, ruler, and time of the grain of rice doubling were different.
The ruler grants the peasant’s request for the doubled grains of rice. Around 20 days he starts to regret the decision as he has to give over a million grains of rice away. Eventually, the peasant becomes the town hero with all the wealth to spread through the town.
Try One Grain of Rice On a Spreadsheet With Your Kids
I found this project with a spreadsheet. I originally found it as a great summary of the story itself, but it’s a great kid-friendly introduction to spreadsheets.
If you get used to using the spreadsheet it will be useful when you try to model one grain of rice with money:
One Grain of Rice With Money
Taking the lesson of One Grain of Rice and applying it to money isn’t a stretch. In the story, rice is essentially the kingdom’s form of currency. (It makes more sense than using bees as currency)
It would be nice if we could double our money every day, but there’s not an investment in the world that would do that. Instead, you may choose to explain that it’s reasonably possible to double your money every 6 years or so. Some parents out there might be familiar with the Rule of 72. The Rule of 72 states that money doubles every X years depending on the growth percentage. For example, if you are earning 5% interest, it will take about 14 years for your money to double – (72 divided by 5 is about 14 years). If you can earn 12% interest, it will only take 6 years for your money to double – (72 divided by 12 is about 6 years).
Assuming a 12% interest rate over the long haul may stretch reality a bit. The stock market has returned that much for long periods, but it’s far from a guarantee. It’s more of an exception than the norm. We’re looking to motivate kids with the power of investing, so you may want to focus on the sunnier side. You also may want to create your own Bank of Dad where you can afford to pay higher guaranteed interest rates (at least for a little while).
You may want to run a few scenarios with your kids. Using that “money doubles every six years” you could find that you have 5 or 6 doubling events by the time they are mom and dad’s age. By that time, a dollar invested at their age might be $32. One hundred dollars would be $3,200. You can blow their minds by going to 10 doubling events in 60 years when a dollar is worth over $1000. Of course, they might not care because it’s hard for kids to imagine a 68-year-old version of themselves.
Most money experts will tell you that the number one money skill is investing. It’s the best way to make a lot of money doing the least amount of work. In fact, you can make a lot of money doing almost zero work. In the United States, it’s often better to own a company than work for a company.
Yes, it’s great to save money. You’ll need to save money if you are going to invest it. However, if you save money and stick it under your mattress, you’ll be missing out on potentially millions of dollars over your lifetime.
Yes, it’s great to be frugal. If you spot a bargain, you’ll have a much better chance to be financially independent at a young age. If you are frugal, you’ll be able to save more money to invest it.
Yes, it’s great to earn money. When you earn a lot of money and are frugal, you’ll be able to save a lot of money and invest a lot of money. Everything plays a role, but investing is where personal finance becomes fun. Where else can you turn one dollar into $32 by doing nothing?
We’ll get to that $32 example at the end. For now, let’s focus on how to teach kids about investing at the various stages of their lives.
Teach Preschoolers about Investing
It may sound silly to teach preschoolers about investing. In a lot of ways it is. At this age, kids have the concept of money buying things like goods and services. However, they don’t have the concept of money making money.
Plant some seeds and water them every day. As the seeds grow into a plant the kid will see the “investment” and the results. If you have a garden, you can show how a few seeds can grow into a lot of real food. When I was a kid, my parents grew tomatoes and cucumbers. We always had tons – more than enough to give away to neighbors.
Read the Little Red Hen. My kids read this in Kindergarten – it was part of their curriculum. Even though they are in the 2nd and 3rd grades now, I still use the lessons in the book. You do the work and you get the reward. The Little Red Hen invested her time and effort and got to enjoy the cornbread.
Teach Grade Schoolers about Investing
For kids in elementary school, my best recommendation for teaching investing comes from The First National Bank of Dad. Author David Owen gives his kids extremely good interest rates to emphasize the point of compound interest. Nowadays, banks fail kids, they are boring locking up money in their vault returning barely more than a zero percent interest rate.
You might also consider explaining the very basics, such as “What is a stock?” This video covers it well in less than 5 minutes:
Teach Tweens about Investing
The options to teach investing around really expand around the ages of 10 to 14. Personally, I love MoneyTime. Over the last couple of years, kids have gotten a lot more experience learning online. It’s certainly not what we wanted and far from ideal. However, it’s very rare to find an in-person class on investing for kids. MoneyTime is a great way to get experts to teach your kids money.
If learning from a computer course isn’t for you, you are not alone. I know I learn best by doing. That means that I have to get my hands dirty and invest. This is a great age to open up a custodial brokerage account and buy some index funds.
Teach Teens about Investing
Unlike younger kids, teens can work real jobs and make a good amount of money. It’s a perfect time for them to invest in a kid Roth IRA. Since their retirement is fifty years away, every dollar invested will grow many times.
This is a great age to introduce them to Rule of 72. The rule of 72 is a way to estimate how fast your money will double. You divide 72 by the interest rate to get the number of years it takes for the money to double. If you were able to earn a 12% interest rate, your money would double in 6 years (72 divided by 12% = 6 years).
I like to assume that money will double every 10 years. That’s a 7.2% return, which is usually a safe estimate. With 50 years of compounding, every dollar can double 5 times. That means that every $1 becomes $2 (age 25), which becomes 4 (age 35), which becomes 8 (age 45), which becomes 16 (age 55), which becomes 32 (age 65).
Turning $1 into $32 is magical. A kid would “only” have to invest $33,000 one time at age 15 to have a million dollars in his retirement account at age 65. Of course, it’s very hard for a 15-year-old kid to earn and invest $33,000. However, all is not lost. A kid could continue to invest for several years and keep seeing that compound interest grow after age 65.
Do your kids have a Kid Roth IRA? If you can manage it, I highly recommend getting one. A Roth Individual Retirement Account (IRA) is an incredible savings vehicle – perhaps the best deal in all of personal finance.
My kids each have one. That’s very rare – I bet none of their classmates have one. They’ve had one since they were around five years old. They’re 8 and 9 now and they have around $2,000 and $3,000 respectively in retirement savings. They didn’t have to pay income tax on the income because they don’t make much money. They’ll be able to make withdrawals completely tax-free and penalty-free at age 59.5. By starting now, they’ve got the most valuable thing on their side – time.
It’s not easy to get a kid a Roth IRA account. The IRS has an annoying rule that the kids have to have earned income to put money into a Roth IRA. Unfortunately, you have pesky labor laws that make it difficult for kids to earn wages. Ideally, you’d have a kid who has earnings from a baby modeling career, but there aren’t enough of those to go around. It would be nice if people lined up to buy art from children, but I’m not holding my breath on that one.
Kid Roth IRAs and Self-Employment Income
How do my kids earn this money to comply with the IRS demands? I pay them to help with my dog sitting business. I typically make around $15,000 a year boarding dogs. It’s a very good side hustle while I’m freelancing from home and writing blog articles. After COVID vaccines became available, I made over $30,000 as everyone got pandemic dogs and every wanted to travel.
I’ve been dog sitting for more than seven years now, so the kids have grown up with a couple of extra dogs around. They’ve become naturally curious about feeding dogs and they love to play fetch with them. We’ve taught them how to pick up the dog droppings, but that’s not something they like. Some of their peers do that chore for their allowance. However, for the family dog sitting business, it’s part of the job.
Feeding dogs, playing with dogs, keeping the water bowl filled, and picking up after the dogs is most of the dog sitting job. These are all things that my kids can do. Occasionally I have to give them medicine. That’s about the only thing that I need to do 100% myself. The IRS should have no issue with me subcontracting out some of the work to them. A professional pooper scooper company costs a couple of thousand dollars a year for the number of dogs we have and how often they’d have to come. My kids aren’t professionals, but the service doesn’t fill the water bowls or play with the dogs, so I think it averages out.
Kid Roth IRAs: Powerful Stuff
A Roth IRA contribution at this age is very, very powerful. Money grows quite a bit over 55-60 years of compounding until they reach ages 65 and 66.
Before we get to my kids’ Roth IRA numbers, here’s a helpful CNBC video about how kid Roth IRAs works. Who wouldn’t want 3.4 million in one of their accounts?
My kids won’t have 3.4 million like the example in the video. If they were to earn 7% interest over that long period, a single dollar would be nearly $58. So $1000 in a Roth IRA would be worth $58,000. Of course, at 3.5% inflation over that time, you’d need $7,878 to have the buying power of $1,000 today.
When you crunch those numbers, it gives them a real post-inflation gain of 7x their money. Theoretically, if they could earn the $6000 Roth IRA limit, they’d set themselves up with $42,000 in retirement. Of course, that would be an extreme amount of dog care and that wouldn’t be reasonable.
In addition to the Roth IRA, we pay them some real spending money. They saved up for a Nintendo Switch before the pandemic. That was great timing because they were hard to find once COVID hit.
The first year, I settled on paying the younger one $400 and the older $600. In the next year, the younger got $600 and the older got $750. Last year, they got $750 and $1000 for each. The dog sitting business is going well with everyone traveling now that they are vaccinated.
My oldest would have an inflation-adjusted amount of $13,443.70 in his nest egg at age 65. My youngest would have to settle for “only” $10,066.02. He should catch up because he’ll have an extra year when my old son moves on.
Investing My Kids’ Roth IRA
You need to open a kid Roth IRA with a brokerage firm. I chose Fidelity because I already had my SEP-IRA with them. They allow you to buy many mutual funds, bonds, and ETFs with no trading fees. However, a lot of brokers have many investment options to manage the Roth IRA assets.
I normally believe in investing in only index funds for them. However, they always have some money left over. With VTI trading at $222, I buy a couple of shares with $600 and have over $150 leftover. That’s when I look at foreign ETFs such as VEU and VWO.
The Future of My Kids’ Roth IRA
In the next few years, I’m hoping they can participate in some of my blogging work. I need to think a little more about how this would work. Of course, I’d pay them for their time and insight, which would be taxable income.
After that maybe they can do babysitting or lifeguard work. I noticed that McDonald’s is hiring 14-year-olds now. There will be more opportunities for them to earn money as they get older. While all this is nice, their core “job” now is to get good grades in school.
Kid Roth IRAs FAQ
I thought I’d add an FAQ because I know that a lot of people have questions about Kid Roth IRAs. Some of these can get difficult, so I urge you to contact your tax specialist. I’m not a tax specialist and I didn’t even stay at a Holiday Inn last night.
Can I open a Roth IRA for my child?
Yes, as long as the kid has earned income. Some popular self-employment gigs for young people are mowing lawns, babysitting, and dog-walking.
How much can a child put in a Roth IRA? Are there IRA contribution limits?
A child can put the same amount into a Roth IRA as an adult. Right now, in 2022, it is $6,000. There are no minimums to what a kid can put in a Roth IRA.
Can a parent contribute to a child’s IRA?
Technically, yes. I am my kids’ parent. With our dog sitting business, I pay them income for the work that they do. I’m acting as a business owner. As a parent, I put some of that money into their Roth IRA.
Do I get a tax deduction for contributing to a Roth IRA?
Unfortunately, you do not get a tax deduction, but don’t let that stop you. If you’ve learned nothing else in this article, you should realize the Roth IRA is an incredibly good deal.
Can my child use a Roth IRA for college?
Yes, there is no early withdrawal penalty for qualified education expenses such as college tuition. However, most financial experts agree that it’s better to let the Roth IRA to compound interest for retirement and save in a 529 Plan for college. 529 Plans are more flexible and don’t have the earned income requirement.
Can my kids cash out the Roth IRA at age 18?
Yes, when they become adults they’ll be able to take control of the Roth IRA. It’s important to teach your kids about money, so they understand that the penalties for withdrawing the money are severe.
I have a question that’s not listed here. How can I ask it?
Today’s article is something a little different – something light to send you into the weekend. Yes, it’s another example of teaching your kids about money with television. What if we could take a kids’ song and make it into a money lesson? I didn’t set out to make this happen. However, spending a lot of time with kids and thinking about personal finance often leads to odd combinations.
Or to put it another way, “Something weird might just be something familiar viewed from a different angle.”
My kids love Adventure Time and it’s good for adults to watch as well. Somewhere along the line, I couldn’t follow the story (it’s very weird). However, I enjoyed the songs, particularly the ones from Marceline (Olivia Olson), so I got the soundtrack for the kids. That’s when one song caught my attention in the car. I would later find out that it made the an LA Times list of top songs that make you cry.
Watch this short 90-second “Everything Stays” from the Cartoon Network show Adventure Time:
In case you aren’t able to watch here are some of the lyrics: (It’s much more meaningful in the full context with the music.)
“Everything stays right where you left it Everything stays But it still changes Ever so slightly, daily and nightly In little ways, when everything stays”
Isn’t that a tremendous description of buy-and-hold investing? Your shares stay, but there are slight daily changes to the value of the shares.
“Go down to the ocean The crystal tide is raising waters’ gotten higher as the shore washes out Keep your eyes wide open, even when the sun is blazin’ The moon controls the tide, it can cause you to drown”
This quote reminds me of watching the warning signs when you own a stock. The last line about the moon controlling the tide is a reminder that the fate of a stock is often out of your hands once you’ve made the decision to buy.
Index funds don’t require you to keep your eyes open. The moon rarely can cause few diversified portfolios to drown.
What did you think? Was this something too weird or familiar when looked at from a different angle? Let me know in the comments.
Kid Wealth is reader-supported. When you buy through links on our site, we may earn an affiliate commission.
I am not a financial adviser. Kid Wealth content is for educational purposes only and the information should not be construed as professional financial advice.