compound interest

Five Ways to Teach Compound Interest

Teach Compound Interest
Look at the difference between compound interest and simple interest!

“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:

  1. 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.

  2. Use a Graph

    There’s a classic example of the power of compound interest that compares two investors. The younger person invests for a few years and then stops after 10 years. The slightly older person invests for 30 years and still can’t match the younger one. Here’s a graph of what that looks like:

  3. 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.

  4. 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.

  5. 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.

Parts of this article were originally published July 8, 2022

Brian MacFarland has reached more than 10 million people on his personal finance journey to financial independence.  He’s been featured in the Washington Post, U.S. News and World Report, and Lifehacker.

Read more on the About page.

If you enjoyed this article please Support Kid Wealth

Teach Compound Interest through One Grain of Rice

Compound interest: one grain of rice

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.

Brian MacFarland has reached more than 10 million people on his personal finance journey to financial independence.  He’s been featured in the Washington Post, U.S. News and World Report, and Lifehacker.

Read more on the About page.

If you enjoyed this article please Support Kid Wealth

The First National Bank of Dad (Book Review)

First National Bank of Dad

The First National Bank of Dad is perhaps the best personal finance book for parents. If it’s not the best, it’s the one I’ve enjoyed the most. It’s also certainly one of the best-kept secret books about how to teach kids about money. For some reason, it only has 35 Amazon reviews – not a lot for a book that is nearly 20 years old.

What makes it so good? I keep coming back to two things:

  1. All the advice makes sense when you think of it from the perspective of the child.
  2. It’s an easy, quick, entertaining read.

You’ll get the most out of it if your kids are around age 5 or 6. It’s perfect for that time when kids are starting to get an allowance. It covers personal finance for kids until about the early teen years – around age 13 and 14. There’s some mid-late teen advice such as who should pay for driver’s insurance and whether a teen should get a summer job, but that’s not the main focus. Author David Owen isn’t afraid to share his strong, often contrarian, opinions, but he brilliantly backs them up.

The First National Bank of Dad is divided into four main parts:

How to Get Your Kid Interested in Saving Money

This section is the biggest concept – it’s right in the title of the book. The idea is to open up a virtual account (a spreadsheet will work fine) where your kid(s) can deposit money and receive 3% interest monthly. You, the parent, is going to pay this interest. That’s why you are the First National Bank of Dad.

Why open up your bank for your kids?

Bank savings accounts fail kids. They pay almost no interest. Kids can’t easily access their money. Kids have nothing to gain by putting their money in a bank. It isn’t interesting or useful from their point of view.

However, The Bank of Dad, paying out 3% interest each month makes a big difference. For example, $100 grows to $142.57 in a year. A child can see how $42+ in free money is useful. Personally, I’m thinking of implementing this at 1% compounded weekly. On a $100 deposit, that amounts to $167.77 in a year, but I get to show it growing every week, which might be more interesting to my boys. After the first year, I will reduce it to 3% monthly (42% annually). For the third year, maybe I would do 5% every two months (34% annually) and finally, the last year I could do 7% every quarter (31% annually).

David Owen acknowledges that the Bank of Dad can’t exist forever – paying a guaranteed 42% annual interest over the long term just doesn’t work. He says that around age 12, the kids wanted real checking accounts and independence, which effectively shut down the Bank of Dad. Since this book is twenty years old, I’m not sure kids are interested in real checking accounts like he claims. However, I could see them wanting access to money without asking for a withdrawal from their parents.

The Bank of Dad on Allowances

Author David Owen is a big believer in allowances. I am too. It’s hard for kids to learn about money when they don’t have any. He recommends not being to stingy with allowances – kids have to have enough money that they can make mistakes to learn from.

He gives some other great tips on how to do allowances right:

  • Ask kids how much they want – include them in the process.
  • If they want an allowance raise, have them “apply” for it in writing justifying why they need or deserve more.

He also offers some things that you shouldn’t do with an allowance:

  • He recommends that you don’t encourage the kids to save, let the awesome compound interest get them excited so it’s their idea
  • Chores are a family obligation. We all need to pitch in. It’s best not to link money to doing chores. Pay for doing extra work.
  • Grades are an obligation. It’s the kids’ job. Don’t link money to getting good grades.

There’s one more that I wanted to address specifically.

Don’t force kids to give.

This is a unique concept as almost all the advice on teaching kids about money has giving included. The reasoning behind this is that it doesn’t give kids the ability to control their money. They can control where to give, but not the act of giving itself. If you force kids to give away one-third of their money (as many recommend), kids will see it only getting two-thirds of their allowance.

This makes sense to me. However, I still want them to give. So what do I do about it? I think the best plan is to give an even higher interest rate for money designated for giving. That might not encourage saving for the purpose of giving – after all, the money would all be going away. However, recently my kids have started to want to give each other presents at Christmas and birthdays. If we count this as giving, then they can scheme up a system to multiply their money faster if they cooperate. Most of the time, my kids don’t work well together, but if they have a shared interest, it might bring them closer together.

The Dad Stock Exchange

When the kids have graduated from the Bank of Dad, they are introduced to The Dad Stock Exchange. The Dad Stock Exchange is just like any regular stock exchange, except that the prices of stock are reduced by 100. If a stock trades at $12.45 it would trade at $0.1245 on the Dad Stock Exchange. Kids wouldn’t buy real stock, but Dad would keep track of the value.

Dealing with smaller numbers is easier. Also, kids can diversify more than they normally would be able to with a small amount of money.

One of the difficulties with the Dad Stock Exchange is dealing with dividends. The author didn’t want to keep up with them. I wouldn’t want to either.

The Dad Stock Exchange may have made a lot of sense in 2003 when the book was written. It may even make some sense today. However, many brokerages allow buying fractional shares and have commission-free trades. As I write this, kids could buy a half-share of Roblox for a little more than $25.

I think it’s better to invest in the stock market for real nowadays. In fact, once the kids were about three, I squirreled away a lot of their birthday money and invested it. At ages 8 and 9 now, they have nearly $5,000 a piece. The stock market has done really well over the last 5-6 years. Also Robinhood had a promotion where they were giving out free stock. Maybe they’ll use this money for their first car someday.

True Net Worth

This section is about understanding that money isn’t everything. There are things that money can’t buy. Essentially David Owen is making the case that quality of life is important. Owens goes through some exercises to show that the most valuable things are memories, not stuff bought with money. It’s an important point to make, but this isn’t any new and/or revolutionary. There’s a reason why I went with Kid Wealth and not Kid Money. Wealth encompasses more than money.

There’s some things in the book that I didn’t find much value in. There was a lot about eBay and Beanie Babies. I think that was more relatable in 2003. It’s good in a historic context. Also, selling stuff on eBay is something that is valuable today. I’m not sure it would make an update edition of the book.

There was also a lot written about the value of reading and reading to your kids. In some ways, I liked how it branched out from more than just a discussion of money. However, I could see many people looking for a book that stays more laser-focused on personal finance and kids. If you are like that, then this book may not be for you.

The True Value of Teaching Your Kids About Money

The author’s father was a life-long money manager. That was his career. However, when the father got older and had some health problems, it became clear to the author that the father shouldn’t actively manage his money anymore. So he tells his father that he has an older friend that needs help managing his money and asks if his dad would do it. His dad says something like “Of course now! Are you crazy? I’m too old and I don’t want to do that anymore.”

Then the author says, “Dad, you are that older friend.”

We help our children learn money today. Tomorrow they’ll be the ones helping us with our money.

If you are interested in learning more there’s an hour-long podcast interview with author David Owens here.

Brian MacFarland has reached more than 10 million people on his personal finance journey to financial independence.  He’s been featured in the Washington Post, U.S. News and World Report, and Lifehacker.

Read more on the About page.

If you enjoyed this article please Support Kid Wealth