Easy ways to explain the concept of compounding to your child

Parents work hard through their lives to provide the best opportunities for their children. They ensure their kids get the finest education and best-in-class healthcare. However, what is often overlooked is teaching them about financial responsibility. As a parent, you must impart financial lessons to your child, and compound interest is one of many essential concepts they need to grasp.

The power of compounding is undeniable. Whether you are saving and creating wealth or borrowing money to fulfil various needs, compounding is vital to your financial well-being. If you can successfully teach your child how compounding works, they will be more inclined to save, avoid mounting debt, and become financially responsible adults.

How compounding works

Albert Einstein famously called compounding the “eighth wonder of the world” and said, “He who understands it, earns it; he who doesn’t, pays it.” 

Compounding is letting your money make money. Simply put, it is interest on interest. Here you are not only earning interest on the original amount but also earning more money on your interest, further growing your corpus. 

Let’s understand the concept with the help of a savings example. Say you have Rs 1,00,000 in an account that earns 5% interest. You would have made Rs 5,000 in interest earnings at the end of year one. By the second year, the total interest earned would be Rs 10,250. The additional Rs 250 is interest earned on the previous interest payout. If left untouched, you would make Rs 64,700 in just interest by the tenth year!

Ways to make compounding exciting for your child

Tell a story

Most good lessons are taught through stories, and children tend to understand and retain stories better. You can even include their favourite superhero or video game characters to entice them. You can talk about the protagonist practising their moves to build strength and agility, which allows them to win more battles and level up. Here, compounding is not expressed in terms of money but through the critical virtues, such as patience and discipline, which are integral to compounding, whether building skill or wealth.

Gamify it

Gamifying is a great way to teach kids about complicated topics. Relay it to them in a way that will encourage them to get involved. For instance, give your child five pieces of candy and tell them they will get an additional piece if they haven’t eaten any candy after an hour. Continue the exercise with a compounding reward at the end of each hour. They would get another piece at the end of the second hour, then two more at the end of the third hour, and so on. This can teach them the importance of delayed gratification.

Teach it practically

However, if you have older children, the most prudent way to drive home the point could be to teach it practically. Do this by opening a savings account for your child. You can then encourage them to deposit pocket money, cash earned from errands, and money received as gifts from relatives in this account. To sweeten the deal, you can tell them that you will deposit as much money as they do at the beginning so that they can start their financial journey. From then on, you can show them the interest their corpus is earning every quarter and teach them how to track compound interest. Lastly, and most importantly, it would help if you pointed out how their savings are growing.

IDFC FIRST Bank’s Minor’s Savings Account can help your children begin their financial journey on the right track. The savings account requires no average monthly balance to be maintained and offers competitive interest rates with a sweep-in and sweep-out facility, as well as unlimited ATM transactions at any IDFC FIRST bank ATM. 

Remember, teach your kids today what can help them improve their future. 

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.