Polliesdividend

Teaching my kids – Part 3: Compound Interest

I will be writing some post to try to educate my kids. I know they are still very young (4 and 7) but it is never too early to start. And the can read these blog posts later on in life 😉 (This is probably the case, because they don’t speak or read English very well at this moment – You got to love an understatement!).

In Part 1 I told you how we try to get them familiar with money and teach them the value of money. I also wrote about their allowance.

In Part 2 I told you how we gave them a raise and talked about setting goals.

About three times a year we go to the bank and deposit their savings. They turn their piggy banks upside down and deposit all the coins in their saving accounts.

With the interest these days on saving accounts in The Netherlands, it is almost impossible to get rich.

Today I will try to write a post, that for them is really hard to understand. However this is, in my opinion, a really important lesson. And I hope that they will learn and understand this over time.

Or as a wise man once said: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it”.

You are probably, at this point asking yourself, why do I try to explain this to my kids?

Well they are still young and have time on their hands. Or: “ It’s not timing the market that is important. It’s time in the market that can make you rich”.

There have been numerous articles written about the importance of starting early. Just look on the Internet and you find lots of them. How can I teach my kids the importance of compounding? How can I make them understand?

I will try this by using some mathematics. So lets take a look at some numbers.

Lets say you invest from your 20th birthday till your 67th birthday € 2,000 annually (67 is the retirement age in The Netherlands at this moment). Your total investment is € 96,000 over the course of 48 years. Well this is really a nice amount. At the age of 67 your account will be worth almost a quarter of a million! More than 3 times you put in!

This is with an interest rate of 4%.

Because you start of at an early age, the power of compound interest worked its magic! If with a 4% interest rate your investment will be tripled over time, imagine what kind of magic a higher interest rate can do.

At this moment the interest rates on saving accounts is really low in The Netherlands (less then 1%). With a little bit investing you can crank up your rates easily. So what will your account look like with 8% you ask?
Well, your original investment will be multiplied by 10! Your account will be worth almost 1 Million!

Okay now where are talking.

So if you start on your 20th birthday, you investment of € 96,000 will be worth almost a million at the age of 67.But what is you will start later in life?

The table (below) shows how much your total investment will be worth at the age of 67.

Starting age Investment Value
20 96,000 980,264
25 86,000 659,166
30 76,000 440,632
35 66,000 291,901
40 56,000 190,678

Wow what a difference a few years make!

Just for fun, lets see how much you need to save per month to be a millionaire at the official retirement age of 67. In the table (below) you see how much you need to invest each month. An interest rate of 8% is used.

Age Monthly savings
20 180
25 255
30 380
35 575
40 880
45 1,375
50 2,230
55 3,880
60 7.900

As you can see, the sooner you start, the better it is!

So, if you start early, you need to invest a lot less each month to reach the same goal. Let time be your friend! That’s the message I want to teach my kids.

This is my third blog about teaching my kids. I hope my kids at the age of say 18 have all the financial knowledge I have right now. This would be a huge advantage for them! And that’s why I started these blog post series.

Did you teach your kids the magic of Compound interest? How did you do it?

Cheers,

Pollie

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6 thoughts on “Teaching my kids – Part 3: Compound Interest

  1. Income Surfer (@IncomeSurf)

    Thanks for sharing Pollie, and bravo. No, I would never ask why you would want to “teach your kids about compound interest”: I understand completely. My son is still small, but I want to give him every advantage…..and to a large degree that means knowledge/wisdom. I think the key to teaching children things is all about keeping them interested and having the lesson play out in real time. The only way I know to do that with compounding interest is to use the “penny doubling for a month” exercise. (You know the one where you double a penny every day for a month…..which becomes millions of dollars). Otherwise, I think lessons like this are too abstract for young kids.

    I hope you have a great week.
    -Bryan

    1. polliesdividend Post author

      I want to give him every advantage too. That is why I try to explain financial things to them.

      The method of double the money every day for a month is a great way. I did not think about that one. Thanks.

      Cheers,
      Pollie

  2. There's Value

    we’ve spoken about investing/saving and our kids before, so I too would not have to ask you why you want to explain compound interest to your kids!

    I think it’s fantastic that you’re doing this, and I do hope they will be able to understand soon.

    Good luck!

  3. DivGuy

    That’s a hard one for such young kids! Of course I know why you want to teach them this precious lesson. I think the penny doubling exercise Income Surfer mentioned is one of the easiest ways.

    Let us know how it goes!

    Mike

  4. Dividend Legion

    Hey Pollie,

    Thanks for sharing! I’ve really been enjoying these posts about financial education. I really wish my parents had instilled these concepts in me from a young age. I will definitely be teaching my (future) kids all about financial concepts as soon as they can understand it – it’s such a valuable advantage in adult life!

    DL

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