Compound Interest
Our mission is to get kids and families to advance their financial literacy knowledge and turn that knowledge into winning personal finance habits.
We achieve this through various educational resources, including articles, hands-on activities, and lively songs.
One of the most important money concepts we want to make accessible and fun for children and families, as well as motivate them to take advantage of, is compound interest.
Understanding compound interest early can empower children with lifelong financial literacy skills, setting them up for a secure and prosperous future, and that is exactly what we want. So, we have created a series of articles, activities, and songs to make it fun and easy for parents, teachers, and trainers to engage children on the topic of compound interest. You will find a list of them toward the end of this article.
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Money Made Making More Money
Essentially, compound interest is interest earning interest over time. It is money made, making more money. The potential results are often described as magical!
Will You Choose Compound Interest as a Friend or Foe?
One critical aspect to consider is whether you choose to have money compound and make more money for yourself or someone else.
Compound interest can be a valuable friend when you save or invest your money and retain those savings or investments over multiple interest-earning periods. Doing so grows and builds your wealth and security.
Conversely, compound interest becomes a formidable foe when you choose to borrow money and maintain a balance on the borrowed amount over multiple interest payment periods. Doing so enriches lenders at the cost of your own financial advancement.
Make Time an Ally - The Clock is Ticking
Understanding how frequently interest is calculated and credited to your account is essential. This applies whether you're depositing funds into savings (known as the principal) or borrowing money.
Whether you're saving or borrowing, knowing if interest accrues daily, weekly, monthly, quarterly, or annually is crucial.
The initial interest-earning or payment period is typically called simple interest. Compound interest, where interest earns interest, begins in subsequent periods.
Time plays a significant role in the effectiveness of compound interest. The longer you keep your money invested or saved, the more interest you'll earn on your initial investment and any accumulated interest.
Conversely, the longer you maintain outstanding balances on borrowed funds, the more interest you'll end up paying to the lender.
Always remember: every day that passes without earning compound interest represents a missed opportunity!
Sooner is Better
The sooner you or your child starts saving, the more compound interest they'll accumulate.
Consider this: if you or they put $100 into a savings account with an annual interest rate of 5%, the account will have a value of $105 at the end of the first year.
The account will earn interest on this $105 balance in the second year. This means the account will earn interest on both the initial deposit and $100, and it will also earn additional interest on the interest it has already accrued, which is $5.
Thus, at the end of year two, instead of the account being worth $110, it will have a value of $110.25. That extra twenty-five cents represents the earnings from the first period of compounding or interest earning interest - $5 earning 5% or $.25.
Every year you retain your savings, the compound effect advances. In year 3:
Your $100 principal earns another $5
Your first year's interest of $5 earns another quarter
Your second year's interest of $5 earns a quarter.
And, the quarter, your first year's interest earned also earns 5% interest.
Every year, the process continues, and the compound effect snowballs, turning into a magical money-making machine!
See our sample compound interest calculation at the end of this article.
Interest Rates Make a Difference Too
The interest rate you earn or pay also plays a vital role in determining the impact of compounding. A higher interest rate results in faster account balance growth over time due to the exponential nature of compound interest.
When the interest rate is higher, the amount of interest earned on both the principal and the accumulated interest from previous periods increases. This accelerates the compounding process, leading to more significant gains over time.
Conversely, a lower interest rate will result in slower growth as the amount of interest earned on the account balance is reduced.
Therefore, the interest rate earned directly influences the speed at which savings or investments grow through compounding, highlighting the importance of seeking higher rates to maximize returns over the long term.
Referring back to the previous example, if $100 were to compound over three years at interest rates of 4%, 5%, and 6%, it would lead to the following sequence of account values:
4% = $112.49
5% = $115.76
6% = $119.76
The total account value differences would only increase with time.
So, we strongly encourage you to get your kids learning and earning compound interest today!
More Resources: Compound Interest
Parents, teachers, and community leaders, we further encourage you to use any or all of the following Sammy Rabbit articles, activities, and songs to engage, educate, and advance the financial education and literacy of the children in your life.
Articles
Activities
Sammy Money Songs
Sammy Money Song Lyrics - Anyone Can Be Rich!
Emphasize and build a conversation and connection to compound interest around the song lyrics: anyone who starts saving and investing early when they are young can grow rich through the power of compound interest.
Sammy Money Song Lyrics - Get in the Habit
Emphasize and build a conversation and connection to compound interest around the song lyrics: you can watch your money grow and grow and grow.
How You Can Help Sammy Rabbit Advance Kids and Families Financial Literacy Levels
Collaborate and partner with Sammy on "1" project in 2024: Menu of Ideas
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Share one or some of your suggestions that will help make it fun and easy for parents, teachers, and community leaders to talk to and teach kids about compound interest.
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Sample Compound Interest Calculation
Here is a compound interest calculation using the following assumptions.
Save $1 a day.
Start saving at age five and do so for 50 years without withdrawing any principal or interest.
Savings earn 5% per year and compound annually.
Period: | Initial | Annual | 5% | ||||
Age | Annual | Deposit | Compound | Deposit | Subtotal | Interest | Total |
5 | 1 | $365 | $0 | $0 | $365 | $18 | $383 |
6 | 2 | $383 | $365 | $748 | $37 | $786 | |
7 | 3 | $786 | $365 | $1,151 | $58 | $1,208 | |
8 | 4 | $1,208 | $365 | $1,573 | $79 | $1,652 | |
9 | 5 | $1,652 | $365 | $2,017 | $101 | $2,118 | |
10 | 6 | $2,118 | $365 | $2,483 | $124 | $2,607 | |
11 | 7 | $2,607 | $365 | $2,972 | $149 | $3,120 | |
12 | 8 | $3,120 | $365 | $3,485 | $174 | $3,660 | |
13 | 9 | $3,660 | $365 | $4,025 | $201 | $4,226 | |
14 | 10 | $4,226 | $365 | $4,591 | $230 | $4,820 | |
15 | 11 | $4,820 | $365 | $5,185 | $259 | $5,445 | |
16 | 12 | $5,445 | $365 | $5,810 | $290 | $6,100 | |
17 | 13 | $6,100 | $365 | $6,465 | $323 | $6,789 | |
18 | 14 | $6,789 | $365 | $7,154 | $358 | $7,511 | |
19 | 15 | $7,511 | $365 | $7,876 | $394 | $8,270 | |
20 | 16 | $8,270 | $365 | $8,635 | $432 | $9,067 | |
21 | 17 | $9,067 | $365 | $9,432 | $472 | $9,903 | |
22 | 18 | $9,903 | $365 | $10,268 | $513 | $10,782 | |
23 | 19 | $10,782 | $365 | $11,147 | $557 | $11,704 | |
24 | 20 | $11,704 | $365 | $12,069 | $603 | $12,673 | |
25 | 21 | $12,673 | $365 | $13,038 | $652 | $13,689 | |
26 | 22 | $13,689 | $365 | $14,054 | $703 | $14,757 | |
27 | 23 | $14,757 | $365 | $15,122 | $756 | $15,878 | |
28 | 24 | $15,878 | $365 | $16,243 | $812 | $17,055 | |
29 | 25 | $17,055 | $365 | $17,420 | $871 | $18,291 | |
30 | 26 | $18,291 | $365 | $18,656 | $933 | $19,589 | |
31 | 27 | $19,589 | $365 | $19,954 | $998 | $20,952 | |
32 | 28 | $20,952 | $365 | $21,317 | $1,066 | $22,383 | |
33 | 29 | $22,383 | $365 | $22,748 | $1,137 | $23,885 | |
34 | 30 | $23,885 | $365 | $24,250 | $1,213 | $25,463 | |
35 | 31 | $25,463 | $365 | $25,828 | $1,291 | $27,119 | |
36 | 32 | $27,119 | $365 | $27,484 | $1,374 | $28,858 | |
37 | 33 | $28,858 | $365 | $29,223 | $1,461 | $30,684 | |
38 | 34 | $30,684 | $365 | $31,049 | $1,552 | $32,602 | |
39 | 35 | $32,602 | $365 | $32,967 | $1,648 | $34,615 | |
40 | 36 | $34,615 | $365 | $34,980 | $1,749 | $36,729 | |
41 | 37 | $36,729 | $365 | $37,094 | $1,855 | $38,949 | |
42 | 38 | $38,949 | $365 | $39,314 | $1,966 | $41,280 | |
43 | 39 | $41,280 | $365 | $41,645 | $2,082 | $43,727 | |
44 | 40 | $43,727 | $365 | $44,092 | $2,205 | $46,297 | |
45 | 41 | $46,297 | $365 | $46,662 | $2,333 | $48,995 | |
46 | 42 | $48,995 | $365 | $49,360 | $2,468 | $51,828 | |
47 | 43 | $51,828 | $365 | $52,193 | $2,610 | $54,802 | |
48 | 44 | $54,802 | $365 | $55,167 | $2,758 | $57,926 | |
49 | 45 | $57,926 | $365 | $58,291 | $2,915 | $61,205 | |
50 | 46 | $61,205 | $365 | $61,570 | $3,079 | $64,649 | |
51 | 47 | $64,649 | $365 | $65,014 | $3,251 | $68,264 | |
52 | 48 | $68,264 | $365 | $68,629 | $3,431 | $72,061 | |
53 | 49 | $72,061 | $365 | $72,426 | $3,621 | $76,047 | |
54 | 50 | $76,047 | $365 | $76,412 | $3,821 | $80,233 |
Summary
Total Deposits | $18,250 | ||||
Frequency of Compounding | Annual | ||||
Interest Rate | $0 | ||||
Simple Interest Earned | $6,661 | ||||
Compound Interest Earned | $55,321 | ||||
Total Combined Interest Earned | $61,983 | ||||
Total Savings & Interest | $80,233 |
RECOMMENDATION: We encourage you and your children to explore various compound interest calculators available online. Doing lots of calculations can be both enjoyable and enlightening, offering a fascinating way to uncover the magic of compound interest.