Explaining Compound Interest - Teaching Children About Money, Part 3

| November 20, 2018
Share |

“Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t, pays it.” – Albert Einstein. If this is true, then we ought to explain to our children how to earn it, not pay it.

The problem is that explaining compound interest can be difficult and boring. See the example below.

Example

  1. $1,000 invested today for 50 years, earning 8% per year, will be worth $46,901.
  2. When discounted back to the present value by inflation of 2.3%, you get $15,045.

 

I might have lost you at “discounted back to present value” and I guarantee you will lose your child trying to explain the importance of this if you just simply explain how it works. Instead, what if we answered the real question - “why do we save?” The answer for most is to give them money at a later time.

So what if we simply said, “Investing $1,000 today is like giving your future self $15,000.”

Then follow that up by explaining how you arrived at that answer using the information above. There are a lot of assumptions that go into that statement so be sure to explain those. They include –

  1. You have to wait 50 years
  2. You have to earn 8% per year which is not guaranteed and involves being invested for growth and being able to ride out periods of volatility.
  3. Inflation has to keep in check. Long-term averages peg inflation between 2 to 2.5%

 

Disclaimer: Alex Voorhees and Reston Wealth Management do not provide legal, accounting or tax advice. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified investment, tax or legal advisor. The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) or strategies may be appropriate for you, consult your financial advisor prior to investing. No strategy assures success or protects against loss. You should consider the investment objectives, risks, charges and expenses of any investment carefully before investing.

Share |