Why Compound Interest is Important (and how to teach it to your kids)

Compound interest is one of the most important financial concepts that your kids can learn – and it’s not as complicated as it might sound. In fact, it’s simply interest that builds on itself over time. The earlier you start teaching your kids about compound interest, the better. Compound interest is a powerful tool that can help your kids build wealth over time. By teaching them about how compound interest works, you can help them make smart financial decisions that can pay off in the long run.

What is compound interest?

Compound interest is a type of interest where the interest is calculated based on the initial principal/investment amount and the interest accumulates over time. In other words, compound interest is earned on both the principal/investment amount and on the already earned interest. Compound interest can be a powerful tool to grow your wealth. When compound interest is working in your favor, your money has the potential to grow exponentially, especially when you factor in time to grow.

How does compound interest work?

It's important for everyone to understand, but especially important for young people to understand early on. Compound interest is when you earn interest on your interest. This is different from simple interest, which is only when you earn interest on the original amount you deposited. With compound interest, your money grows much faster because you're earning interest on both the original deposited amount and the interest that has already been earned.

For example, let's say you save $400 a month in a shoe box in the back of the closet (guess what, leaving money in a NON-INTEREST bearing bank account is the same as the shoe box) for 10 years. At the end of 10 years, you’d have exactly $48,000 which sounds like a lot BUT what could that turn into if compound interest was working with you?! At only a 10% annual return, a $48,000 investment could turn into $81,938…that’s $33,938 of FREE money… that’s what compound interest does FOR you!

It's never too early to start teaching your children about money and financial responsibility. Who wouldn't want $48,000 to turn into $81,938?! Compound interest is a vital financial concept that your kids need to learn – and it’s not as complicated as most think. Again, compound interest is simply interest that builds on itself over time.

Challenge: If you’ve never used a compound interest calculator before, check this one out HERE. Are you ready to begin making compound interest work FOR you? Check out exactly how much money you have available to start investing! Using the budgeting spreadsheet, total your monthly income and your main S.T.U.F.F. expenses, along with the minimum debt payments. Once your expenses and minimum debt payments have been subtracted from your income, plug that amount into the online investment calculator in the monthly contribution field. Enter your current age. Add either 20 or 30 years to your current age and enter that age in the age you plan to retire field. Just for fun, enter 0 for current investments. Enter 10 in the annual return field and CALCULATE!

Let me know in the comments how much your investment can grow into over the next 20 or 30 years at 10%.