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Top 5 Money Concepts to Teach Your Kids

4. Embrace the power of compound interest

There's an apocryphal tale that Albert Einstein, when asked to name the most powerful force in the universe, answered "compound interest." While the story may not be true, the concept certainly is. Compound interest simply means that the rate at which your money earns interest increases over time.

You can teach your kids about the power of compound interest with a simple exercise. Put a penny on one side of a table, to represent an account bearing compound interest, and a dime on the other side of the table, to represent an account bearing simple interest. Ask your child which will grow to a dollar in fewer steps: the penny, if you double it at each step, or the dime, if you add an additional ten cents at each step.

Need a hint?

  Compound Interest Simple Interest
Step 1 $0.01 $0.10
Step 2 $0.02 $0.20
Step 3 $0.04 $0.30
Step 4 $0.08 $0.40
Step 5 $0.16 $0.50
Step 6 $0.32 $0.60
Step 7 $0.64 $0.70
Step 8 $1.28 $0.80

The penny, representing compound interest, has grown to $1.28 by the eighth step. The dime has become only 80 cents. The difference will only continue to widen. This will help your child to learn the importance of giving her money the time to grow in an interest-bearing account. What starts off as a little bit of interest will, given enough time, eventually become an enormous amount. The earlier you start saving, the better.

5. Beware of credit

Credit cards can be valuable tools in a healthy financial lifestyle, but kids need to be taught from an early age that credit cards are not free money. Here, again, you can give age-appropriate lessons in how credit works by simplifying the concepts and acting as your child's bank.

If your child wants an item that costs $20, you'll agree to extend credit, under the following terms.

  • There is a grace period of one week, after which the interest will start to accrue.
  • The interest rate is 20% per week.
  • The minimum payment is $5 (or whatever her allowance may be).

How will that work out?

  Balance Interest Accrued Minimum Payment
Week 1 $20.00 $0.00 $5.00
Week 2 $15.00 $3.00 $5.00
Week 3 $13.00 $2.60 $5.00
Week 4 $10.60 $2.12 $5.00
Week 5 $7.72 $1.54 $5.00
Week 6 $4.26 $0.85 $5.00
Week 7 $.11 $0.02 $0.13
Total $0.00 $10.13 $30.13

If your child pays only the minimum, she will end up paying $10.13 more for the $20 item over a seven-week timeframe -- and sap her allowance every week. The sad part is, these terms aren't that different from the ones offered by the credit card companies!

You can adjust any of these lessons to suit your own kids and circumstances. No matter what, teaching your kids about money now will pay off later.

More on: Money and Kids

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