ARTICLES
WRITTEN BY SAM X RENICK
(A.K.A. SAM, SAM, THE MONYEY MAN):
How
to Teach Kids About Compound Interest! ©
By Sam X Renick
Whoever
came up with the saying "money does not grow on trees" should
be fired. I assume they either didn't read or agree with Benjamin
Franklin who said "money is of a prolific generating nature."
Wouldn’t it be wiser to use the “money
and trees” saying to motivate kids and young adults to become
disciplined savers and investors?
It’s a perfect metaphor to help explain the compounding principle.
Just ask kids to picture orchards and orchards filled with trees,
filled with fruit, filled with seeds, which all started from one seed.
After all, compound interest is one of the most-compelling and
persuasive tools available to encourage short-term sacrifice for long-term
gain. Furthermore, disciplined savers and investors are rarely free
spenders, thus accomplishing both objectives.
Money’s ability to
compound is of one its’ most intriguing and beneficial features.
Compounding does not discriminate. Its magical characteristics work
for anyone who chooses to employ it, regardless of their ethnic, economic
or social background.
The concept is so powerful, Steve Rosen, Kansas City Star Kids and
Money columnist, wrote that it’s possible over a lifetime to
become a millionaire while earning minimum wage. As incredible as
that sounds, the math bears it out.
One of my favorite ice breakers to help initiate a conversation regarding
this astounding principle is by asking the old question, “would
you rather have $10,000 or a penny a day doubled for 30 days?”
It turns out that a penny a day doubled for 30 days adds up to more
than 10 million dollars! Of course, no investment doubles daily, but
it’s a fun way to introduce this important concept.
Another great ice breaker is to ask how many times a dollar would
have to double in order to reach a million dollars? The answer is
20. You can then add to the fun by asking “how much money a
person would have after ten doublings of the dollar?” The answer
is $1,024. Half the work amazingly equals less than one tenth of one
percent of the benefits. What a huge error it would be to become distracted
and disrupt the doublings at this point, say to purchase an X Box,
a Home Video System or some other “necessary” item.
The largest doubling is the last doubling, which is worth $524, 288
and is equal to the sum of the first 19 doublings. However, the twentieth
and last doubling isn’t possible without the first and smallest
doubling, from one to two.
When something compounds, it grows at a much more rapid rate than
one expects. Time is a major ingredient in the compound interest formula,
so the longer money remains deposited or invested, the greater and
more magical the compounding effect. This explains how it’s
possible to become a millionaire over a lifetime while earning minimum
wage.
Let me provide you a few examples of this principle in action.
If an 18-year-old saves $100 per month and earns 6% until the age
of 65, he or she will have accumulated $313,187, while only investing
$56,400. However, if he or she delays the decision until age twenty
five, he or she will accumulate only $199,149, while investing $48,000.
The difference is $114,038.
If the saver happens to earn a higher return of 9%, which is possible
but requires more risk, than the difference in either deferring or
being unaware of the decision is even more consequential -- $420,417.
The 18-year-old would accumulate $888,549 versus $468,132 for the
25-year-old. The actual dollar difference in what they would have
invested would be $8,400. Whether they earned 6% or 9%, earning an
additional $114, 038 or $420,417 by starting sooner rather than later
is a smart way to accumulate money.
Simply stated compound interest allows the saver to earn interest
on interest as opposed to just interest on principal. For example,
assume money deposited for one year earns one hundred dollars
in interest. During year two, the original money deposited
will earn another year's worth of interest or an additional
one hundred dollars. However, during year two, the one hundred dollars
of interest earned in year one also earns interest, catalyzing the
compounding effect.
Fortunately, you don’t necessarily have to be able to explain
this principle in order to use it as a motivational tool. All you
have to do is expose kids to a compounding chart or calculator. You
can find charts in personal finance books and financial calculators
online. I suggest the online calculators because you can personalize
saving and investment projections, which will add more motivational
fuel to the fire. Or you can always ask your local credit union or
bank manager for help.
In summary, the sooner one starts, the less it takes to reach one’s
goals. So, if it is security and riches you want to create, start
saving and investing early, not late.
Sam X Renick is the author of two financial books for children: It’s
a Habit, Sammy Rabbit! and Will Sammy Ride the World’s First
Space Coaster?; he also produced the music CD titled Get in the Habit!;
and is the founder of The It’s a Habit! Company, Inc., a socially
conscious corporation dedicated to providing parents and educators
with wholesome, entertaining and educational tools that help them
encourage children to develop good habits, especially saving money.
Did You Know?
Did you know splurging on a $3 coffee drink daily for a 15 year old
is a one million-dollar life time decision? The same can be said for
drinking two, 16-ounce bottles of designer water daily versus purchasing
store bought water by the gallon. Ditto sodas purchased by the can
or 20 ounce bottles versus by the liter.
What other million dollar habits and decisions do you see kids making?
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