So what was that maths at school all about again? Hands up anyone who remembers the Quadratic Equation? Your teachers may not have told you why you needed maths except to say “You need it when you grow up.” After that, depending on how good you were at the subject, you either got on with it or wondered what on earth they meant. If someone had said to you back then “If you take one quid now, you miss out on much more later on” would that have made more sense?
We’re talking of course about Compound Interest. It’s a simple concept and one we should all know: rather like being able to do simple percentages it will tide us through our financial lives. If you’re one of those people who understands compound interest but can’t explain it this might help. And if you have no clue about it, then this will really help both you and your children understand this most important of financial principles.
Compound interest is calculated not only on the money you originally invested, but also on any interest the investment has already earned.
For example, 10% on £100 is £10 = £110.
Compounding is when the interest earns interest.
£110 earns £11 = £121
£121 earns £12.10 = £133.10
£133.10 earns £13.31 = £146.41.
Money Grows Over Time
Remind your children that they have something up their sleeve when it comes to investing. Time. So it doesn’t matter how small the amount of money, they have the chance to build a nest egg – or an empire! That is the beauty of compound interest. While we are currently in a low interest phase, which is not likely to change in a major way soon, it doesn’t alter the principle and the benefits of compound interest.
Even £1 saved will yield benefits. Now for the sake of teaching let’s take the following example. It’s offering a whopping 50% interest but it’s an easy one for everyone to follow and if you have younger children as well (or older ones who tune out when numbers are mentioned) this should get their attention.
Put a pound in a jar in the kitchen or family room.
The next day, add 50 pence to the jar. This is 50% interest.
On the third day, add 75 pence to the jar (50% of the amount in the jar, £1.50).
On the fourth day, add £1.13 (50% of £2.25).
On the fifth day, add £1.69 (50% of £3.38).
On the sixth day, add £2.54 (50% of £5.07).
On the seventh day, add £3.81 (50% of £7.61).
There is now a grand total of $11.42!
Ok, so nobody is going to give them 50% interest, at least not in this lifetime but it does illustrate very clearly how money grows and how instant gratification is not always the best option. Plus it serves as a good reminder to the whole family in times of temptation.
Do your children want to know?
It’s fair to say that this is the sort of practical information children do appreciate. Not to cast any aspersions on various branches of mathematics but these are numbers they know they can use. This simple concept is one that will stay with your children. It’s irrefutable and helps them understand what can actually be done with money other than spending it. The future is uncertain, leaving many things out of our control. One thing is for sure — money gives you freedom, choices and security. Teaching children how to control and multiply their money is a (relatively) simple tool to equip them with. And in an era of instant online temptations, it’s probably one we need to remind ourselves of now and then.