The power of compounding is the most important investing lesson you will ever teach your kids
Albert Einstein once remarked, “Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn't pays it."
Some parents assume investing is too hard a concept for their kids to understand. Sure, you may teach your child to save their pocket money, but do you delve into more weighty financial topics like the principle of compounded wealth?
Understanding compounding interest is a vital life lesson for kids to learn. The earlier they learn and apply this lesson, the sooner they can attain financial freedom. Here are a few ways you can demonstrate to your kids how compound interest works.
1. Explain the difference between saving and investing
First, your child needs to learn the difference between saving and investing. Start by explaining what interest is and how money earns interest. They need to understand that not all savings accounts earn interest, and some earn only a small amount.
Next, explain that there are other types of investments that can make money grow faster. This may not make sense to them at first, so read on for tips on how to help them understand what interest is and how it makes money grow.
2. Make it relatable
Kids relate to things like stories, toys and candy. So use something they value to bring this idea across in a practical way.
For example, put one lolly in a treat jar. Explain to your child that if they eat the lolly, there will be nothing left in the jar. But if they leave the lolly for 24 hours, it will double to two sweets – like magic! You can continue for a week, adding a lolly every day.
The message is even stronger if you have more than one kid. If one child ate their lolly and the other saved theirs and has seven lollies by the end of the week, it drives home the message that exercising restraint can pay off in a big way.
Not only does it help them understand how money can grow if left for a period of time, but they also learn the principle of delayed gratification.
3. Turn it into a game
Money games teach financial literacy in a fun way. Of course, there’s the old favourite, Monopoly, which is great for learning how investing in property can build wealth.
But there are other money games you can use that teach kids to be smart with their money.
Moneysmart.gov.au has a downloadable activity sheet on compounding interest for kids aged 7-10 with exercises on calculating compound interest in different scenarios.
4. Get your kids set up on a digital finance app
Get your kids set up on a digital finance app, like FLX, so they can start to manage money in the real world. With FLX, their account is linked to a prepaid FLX Mastercard that you can transfer pocket money into.
Your child can choose to spend or save their money. You can encourage them to save with incentives. For example, if they’re saving towards an expensive item, tell them you’ll match their savings dollar for dollar to help them reach their goal faster. This, again, reinforces the idea that delayed gratification can help you meet big financial goals sooner.
FLX is a Flexischools initiative. Learn more about FLX here.
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This is general advice. Read the PDSs & TMDs at www.flexischools.com.au/legal before deciding if FLX is right for you. The FLX Services & Flexischools are provided by InLoop Pty Ltd ABN 27 114 508 771 AFSL 471558 (trading as Flexischools). The FLX Prepaid Mastercard is issued by EML Payment Solutions Limited ABN 30 131 436 532 AFSL 404131 pursuant to license by Mastercard Asia/Pacific Pte. Ltd.