Compound Interest
Teaching kids to save and learning the miracle of compounding can be a very valuable lesson for kids . Compounding is an interest earned on not only the principle but the interest earned over a period of time. It is an income earned by reinvesting an interest received, thereby the principle is grown and therefore more interest is received in the next period. Term deposits are a good example to demonstrate compounding.
invest Principal >> earn Interest
earn Interest reinvested into Principal >> bigger Principle
invest bigger Principle >> earn bigger Interest
The above steps repeat itself as long as the money is kept in account and not taken out. If regular deposits are made to the account, the interest income will be earned more frequently and the princle will grow even faster.
In mathematical formula, compounding can be described as the below equation.
FV = PV (1+i)n
FV = future value of investment
PV= present value of investment
i = interest rate for the period
n= number of frequency (the number of times that interest is calculated and paid over a period)
It is important to teach children to fully understand the effect of compounding so that they understand that compounding is long term and consistent savings are all it takes to achieve their financial goals. Teach children to save and take advantage of compounding over years to come.