Compound interest can be a tricky idea even for adults who are comfortable with money — the concept of your cash earning interest, and that interest earning interest in turn, is often hard to wrap your head around.
Now imagine trying to convey compound interest to a child who is just beginning to learn about saving and money responsibility.
If that sounds daunting, don’t worry: it doesn’t have to be as complex as quantum physics. At its core it’s about how time changes the value of money.
Here are some straightforward, kid-friendly ways to describe compound interest.
First, Describe What Interest Means
“Interest” is a term we often assume people know, since we rarely have to define it aloud.
Keep the explanation short, especially for younger children: interest is what a bank gives you for keeping your money there. The longer your money remains, the more you accumulate.
Get them thinking with a simple question. Ask if they’d prefer to have $10,000 immediately, or a single penny.
Most youngsters will pick the bigger sum.
Then expand the scenario and don’t hesitate to exaggerate to illustrate the idea. Say the penny doubles in value every day if left in the bank. Do they still want the $10,000, or would they take the penny now?
At that impossible pace, after 30 days they’d possess more than $5.3 million. By day 31, it would exceed $10 million! While that’s unrealistic, it drives the point home.
You should also cover the flip side of interest: paying it.
When bills aren’t settled on time, interest accumulates — but rather than increasing your money, your balance grows against you. This idea becomes especially important as kids near the age they might receive a first credit card.
Even very young children can grasp accruing interest the next time you lend them a few dollars. Explain that borrowed cash also gathers interest until it’s repaid.
Tell them you’ll loan the $5 they want, but they’ll actually owe $5.25 for borrowing it — and if they delay repayment, that debt will continue to increase.
After you’ve given a basic account of what interest is, try these activities to show how it works:
1. Teach That Patience Brings Rewards
Before bringing out coins and bills with little kids, demonstrate the benefit of saving over spending using the classic marshmallow experiment.
Offer your child one marshmallow (or favorite sweet) and say if they don’t eat it now, they’ll receive another tomorrow. Tomorrow they’ll have two, and if they keep them, three the day after that.
This offers a clear, hands-on lesson about how postponing instant pleasure can increase something’s worth, as Kasasa notes.
2. Show Earning Interest with Coins and Bills
Give your child a piggy bank or a clear jar, suggests Jason, a writer behind The Frugal Dad and dad to an 8-year-old. Offer a pile of pennies and ask them to drop one cent a day into the “Mom or Dad Bank.”
Every other day, as they keep adding coins, place an extra penny into their bank as “interest.”
You could match them penny-for-penny, but as Jason points out, “I didn’t want to create the unrealistic expectation that it’s simple to double your money quickly.”
Later on, mix in paper money and different coins to show the variety that makes up currency.
This parent-run bank can function like an ATM: kids may withdraw anytime, but frequent withdrawals mean there’s less left to earn interest. That builds motivation to let their funds accumulate and teaches them about decision-making.
3. Turn It Into a Game
Lessons stick better when they’re enjoyable.
Try the checkerboard trick. Start with a big bag of coins. On Day 1 have your child place a penny in the bottom-left square of a board.
Each day they get double the “interest” from the banker (you) and place those coins in the next square. On Day 2 they’ll have two pennies, Day 3 four pennies, Day 4 eight pennies, and so on.
When they’ve added enough coins that they tumble off the stack, they’ve reached their savings target.
4. Build a Visual Tracker
Is there a toy or present your child really wants?
Make a bargain: if they save to a specified amount, you’ll purchase it. Decide up front what interest rate they’ll earn on their savings, such as 5% or 10%.
To help children watch their savings and see compound interest in action, use visuals. Create a savings chart and hang it where they can see it.
At the end of each week (and especially each month), update the chart. Note how much is in their account and how much interest has been added.
Part of the arrangement might be that they’ll use some of their interest-bearing savings to buy the item — a useful segue into budgeting conversations.
How Have You Shown Your Children Compound Interest?
While offering a 40% or 50% rate is useful for demonstrating compound interest effects, be sure to explain that real bank rates are much lower.
Over time you can help them navigate other interest-related topics, like how credit cards work, car loans, student loans, or mortgages.
Your Turn: Have you taught your children about compound interest? What tactics or games helped illustrate the idea and taught them how powerful it can be?
