This is a guest post from Grant Baldwin, the author of Reality Check, a book about helping students transition into the real world. His new website, BrokePiggy.com, answers questions from teenagers about personal finance, savings, and all things money.
This series “12 Things Every Teenager Needs To Know About Money (And How To Teach Them)” is a community blog experience. This post is only one of the 12 points in the series so to view the other 11, please visit the list of links below.
Two Words: Compound Interest
We all remember those days of sitting in a math class listening to a teacher talk about theorems, abstract algebra, or differential equations. And the entire time this lecture was going on, we all asked ourselves the same question:
When am I ever going to need this?
Don’t deny it. You had the same thought I did. And a lot of class periods that question popped into our minds except for the day we talked about (wait for it)…
Compound Interest.
Ok, maybe you still didn’t grasp compound interest then, but hopefully you’ve seen the light by now and wished you did grasp it better back then! When it comes to personal finance, that one simple math concept can be your best friend or your worst enemy. Here’s one way of looking at it…
Which one of these options would be worth more?
- Ten thousand dollars per day for 30 days.
- One penny that doubles every day for 30 days.
Option #1 would be the better choice for the majority of the time until you look at how the race finishes up. By the end of 30 days, option #1 would be worth $300,000. Not bad at all. But by the end of 30 days, option #2 would be worth (drum roll please)…
$5,368,709.12!!!
Pretty wild huh? So how do you teach this to a student? Here are some tips…
- Show Them The Numbers — Although most teenagers aren’t “number nerds,” they can still see that $5,368,709.12 is a better option than $300,000. When students look at the possibilities and you teach them they have an advantage, even over you as the parent, it begins to click for most teenagers. Time is on their side.
- Help Set Up A Roth IRA — The best investment option for taking advantage of compound interest at a young age is by setting up a Roth IRA. The only eligibility requirement is that your teen has an earned income.
- The Tortoise Always Wins The Race — Adults aren’t the only ones looking to get rich quick. Teenagers fall into that category as well. Part of your role as a parent is to teach them how slow and steady wins the race. Teach students to not count on striking it rich in the lottery, winning big on Deal or No Deal, or opening their front door to the prize patrol. The rabbit may seem faster but the consistency of the tortoise wins the race.
Curious about the other 11 things every teenager needs to know about money? Check them out at the following sites:
- Money Doesn’t Grow On Trees @ Bargaineering.com
- Two Words: Compound Interest @ PoorerThanYou.com
- Delay Gratification To Succeed @ GatherLittleByLittle.com
- Living On A Budget Isn’t An Option @ TotalCandor.com
- Credit Cards Will Steal Your Lunch Money @ PTMoney.com
- A Degree Is An Expensive Piece of Paper @ TheDigeratiLife.com
- Spend Money Based On Needs Not Wants @ MoneyNing.com
- There Is More Free Money Than You Realize For College @ FreeFromBroke.com
- Living On Your Own Isn’t Cheap @ Studenomics.com
- Taxes Are A Necessary Evil In Life @ MoneySmartLife.com
- Do What You Love, Love What You Do @ GenXFinance.com
- Don’t Be A Tightwad: Give Generously @ CashMoneyLife.com
Compounding is some powerful stuff!
Compound interest is probably one of the few math classes I understood!
This is one of the most important things to know when you’re a teen — because the longer you save, the more money you’ll have. Wish I knew that when I was blowing my allowance back in the day!
I’m really enjoying this series. Check out my Q&A with BrokePiggy’s Grant Baldwin (not officially part of the series, but if you’re interested in his story and why he started BrokePiggy, check it out) http://www.hereverycentcounts.com/2009/04/broke-piggy-teaches-teens-about-money.html
Great, now I have 11 more posts to read through tonight 😛
Seems like a good time, though!
Thanks for your involvement in this series Stephanie!
This is really great stuff. If only we had learned these things before we were able to obtain credit cards and such…
Awesome stuff. I wish they taught money management in school. Young people really need to know about money before they get into the real world, or they will end up in debt like everyone else.
The book I just reviewed (and am giving away 2 copies of!) was written just for young people about money management and covered compound interest in detail. They really should change the schooling curriculum to be more in depth about money, my econ course was a joke.
Hey, that’s a great compounding interest question to put in my back pocket for future use. Very teachable. Man, if i’d only started earlier. That’s what we all say I guess.
I’ll definately have to remember this for my son. He needs all the help he can get when it comes to saving.
This isn’t just for kids, I learned a thing or two as well. Guess you can never be too young or too old to learn something new. Keep up the good work.
I knew SO little about money as a teen, and unfortunately it would lead to financial idiocy until my early 30s. I didn’t understand insurance, investments, savings, ANYTHING. Financial wisdom will be something that I teach – and demonstrate – to my daughter (now 4) as she grows up, to hopefully avoid these pitfalls.
Jerry
This is a great post. I’m currently trying to teach my 5 year old about the importance and value of money. Amazingly, she is getting it, and I think it is going to have a profound impact on her financial future.
Thanks,
-TAM
Great piece Brandon. We recently posted about the same topic titled “Teaching Kids Smart Money Habits.”. Here’s a link if any of your readers are interested in checking it out:
http://blog.findabetterbank.com/dollars-and-sense-teaching-kids-smart-spending-and-saving/
Rob
I dont understand how doubling a penny for 30 days will give you 5 million dollars…
@Jeremy: Here’s what it looks like if you took a penny and every day doubled the amount, for 30 days:
Day 1: $.01
Day 2: $.02
Day 3: $.04
Day 4: $.08
Day 5: $.16
Day 6: $.32
Day 7: $.64
Day 8: $1.28
Day 9: $2.56
Day 10: $5.12
Day 11: $10.24
Day 12: $20.48
Day 13: $40.96
Day 14: $81.92
Day 15: $163.84
Day 16: $327.68
Day 17: $655.36
Day 18: $1,310.72
Day 19: $2,621.44
Day 20: $5,242.88
Day 21: $10,485.76
Day 22: $20,971.52
Day 23: $41,943.04
Day 24: $83,886.08
Day 25: $167,772.16
Day 26: $335,544.32
Day 27: $671,088.64
Day 28: $1,342,177.28
Day 29: $2,684,354.56
Day 30: $5,368,709.12
In other words, it’s 1 cent invested at 100% interest per day – not an investment you’ll find anywhere in the real world, but a cool demonstration of the power of compound interest nevertheless.
Teaching teens how to handle money is important and not something they are likely to learn in school. If you teach your children smart ways to manage money, it will help to ensure they get the right start and don’t wind up with bad habits.
If there is one way to make maths easier for teenagers, its to talk about money! Once they see how much this subject can benefit them in the real world, they’ll start to pay closer attention. Also, another good way is to break down the relevance in professions like engineering, astronomy etc. This is guaranteed to help them take the subject more seriously.