Standing at the stoop of the porch, with his arm engulfing my scrawny set of shoulders, my father asked me to look out upon the backyard. “…Son, I’ve planted many of those trees, you see, here,” he chimed. “The one in the corner spits out crabapples. That one there, annoying little acorns. We get pine cones from that white pine. What you don’t see, Son, is any tree that produces dollar bills…”
Having no desire to ingest yet another life lesson from Dad, my intention was to plead my case, for the ten bucks needed for the box of baseball cards, with Mom, instead. However, before I could escape, I heard the groan of my Dad’s wallet being opened.
“I’m going to give you the ten dollars you need,” said Dad, exposing a crisp and clean sawbuck to the breeze of the summer morning. “…But, thirty days from now, you’re going to pay me eleven dollars for this ten-dollar bill…”
And, with that transaction, came my first exposure to borrowing money and the power of interest.
While kids may understand the idea of setting aside money in a rainy day fund or to buy a new video game, grasping the concept of interest and the power of its ability to add wealth or compound debt can be a little more difficult. After all, one of the greatest minds of the 20th century, Albert Einstein, is alleged to have concluded compound interest is the eighth wonder of the world. However, one does not need to possess the IQ of Einstein, a MBA from Wharton, or be a wealthy tycoon to gain a working knowledge of interest.
Whether it is the balance we may carry on our credit card or the earnings we may reap from investments, compound interest has the potential to impact our financial stability, both positively and negatively. Learning the elements of compound interest and its impact on said stability is essential, not only for adults, but children and teens, as well. Of course, one needs not a classroom setting for discussion. As is such, the theory of interest can be conveyed, practically, to children and teens. The following are ideas for teaching the value of interest on earning, lending, and borrowing:
Time is on your side
Using the concept that most banks provide customers, paying a rental fee, per se, to use those customer’s money, children can learn that the longer money is compounded, with interest, the faster the money has the opportunity to grow.
- For example, provide your child with a given allowance, at the beginning of a month. Tell your child that for every dollar they save, instead of spend, he or she will earn a dime, at the end of the month. In essence, the child is developing a quasi-bank account.
- Continue the practice, from month to month…provided, of course, your own budget can handle a frugal child. In doing so, however, you can teach the child the difference between saving and spending money, and how a savings amount can grow, with the help of interest.
Borrow money from them
If your teen or child receives an allowance or has an amount that they have stowed away in a shoebox or under their mattress, ask them if you could borrow a couple of dollars…provided the child wants to depart with his or her money. At the end of a week or month, return the money to your child, along with a nominal extra amount, say a quarter or two quarters.
With such a transaction, you can teach your child the significance of lending money, and the effect of interest on lending money.
- Explain to your child, in the business realm of lending money, there is a potential cost associated with such an endeavor, i.e. interest. Banks and lending agencies will extend money to customers, but in return, not only will these financial institutions demand repayment of the amount borrowed, they may also desire to be paid the amount charged to borrow the money.
Extend credit for a purchase
When your child requests money for that video game or other novelty that you may find frivolous, acquiesce, and lend them the money. Along with the money, however, provide your child with an explanation of the terms for extending them the finances for the purchase.
- Indicate that should the full amount of credit granted not be repaid, within 30 days, a nominal amount will be charged for the outstanding balance due.
- Allow your child to make as many payments as they desire toward their debt, within the 30 days, keeping track of the money that is paid back to you.
This simple exercise can teach your child the very basics of credit and how interest can impact the outstanding balance one carries on credit cards.
- Should he or she repay the full amount, within the 30 days, the implied contract has ended, and your child simply used the credit to extend out payment for the video game.
- Should there be an outstanding balance remaining, beyond the initial 30 days, prompting a charge amount, the opportunity exists for you to explain the pitfalls of interest on using credit.
- By not repaying the full amount, within the time required period (30 days), the actual cost of that video game may be $55, instead of the listed $50 that was paid to the store.
As you talk to your children about money and its ability to grow over time, with the help of interest, ensure that you reinforce the concept that compound interest can be a double-edge sword. If one routinely saves, compound interest can be one’s best friend. However, compound interest can also be a cruel ogre if one gets into the habit of borrowing money.