From budgeting and income to saving and earning compound interest, kids need to learn how to earn money and make it grow. Communicating some of the more nuanced lessons can be difficult, but compound interest is an easy topic that even the youngest children can understand.
The marshmallow game is a great way to teach kids about compound interest and how it works!
How to play the marshmallow game
Here’s how it works!
Simply give a young child a single marshmallow. Challenge your child to not eat that marshmallow, and instead hold on to it for just 10 minutes.
If they succeed in delaying gratification and still have that original marshmallow at the end of the time, they get one more marshmallow. Now you escalate the challenge and the reward.
If they don’t eat either of those marshmallows for another 10 minutes, you’ll add on two more. If they can delay gratification and invest in the “future,” at the end of 20 minutes, they’ll now have four marshmallows.
At the end of the game, explain that this is how compound interest on a savings account works. You leave your money unused in exchange for the reward of making more money. Just as those tasty marshmallows added up, so will their money.
Now show your math
This works best if your child already has a general understanding of multiplication and percentages
When you deposit your money in a bank savings account, you earn interest. So if you open a savings account with $1,000 and your interest rate is 2%, at the end of the year, you’ll have $1,020, even if you made no other deposits throughout the year.
The next year, if you don’t touch that money at all, you’ll earn 2% on the total balance of $1,020. At the end of the second year, you’ll have earned another $20.40.
This repeats over time, gradually earning more interest each year.
Sounds sweet, right? It is!
Compound interest is one sweet lesson to learn, no matter your age
For you kids-at-heart, let’s take a look at how the idea of compound interest can affect line items on your budget.
In an excellent video blog, financial literacy activist Rachel Cruze uses some very down-to-earth examples to explain how compound interest can turn a car payment or average credit card balance into big bucks if you were to save that money rather than spend it. Cruze points out that banking the average monthly car payment of $478 between the ages of 20 and 60 would yield more than $2 million thanks to compound interest!
So go on! Dig through the pantry to teach the marshmallow game to your children. And think about ways you might be able to leverage compound interest to build your wealth, too.
By Wayne Mulligan, on Thursday, June 11, 2020
It’s one of the most powerful forces in investing.
Warren Buffett regularly cites it as the key to his $76 billion fortune…
And Albert Einstein himself reportedly said it’s “the eighth wonder of the world.”
I’m referring to an investing concept known as compound interest.
And today, I’ll show you how you could take advantage of it to build a massive portfolio — and earn big, quick returns!
Turn One Penny into $5 million
When I was eleven years old, my friend’s dad offered me a deal:
He’d give me $1,000…
And in exchange, I’d owe him a payment of one penny right away… and then a payment that doubled each day for the next 30 days.
$1,000 today versus a few pennies later? I jumped up to shake his hand. “I’ll take it!” I yelled.
He then showed me my mistake. You see, doubling a penny each day over the course of 30 days leads to enormous numbers…
On Day 30, I’d have owed him a staggering $5.3 million.
And this same concept is behind the power of compound interest.
Compound Interest in the Real World
Here’s how it works in the real world…
Over the long-term, the stock market returns an average of about 6% per year.
But investors like Warren Buffett have earned roughly 20% per year.
Here’s what that difference would mean for an investor like you…
In 1965, the year Buffett started his investment firm, let’s say you invested $1,000 into a portfolio of stocks, and $1,000 with Buffett.
Today, your $1,000 stock portfolio would be worth about $24,650…
But your “Buffett Portfolio” would be worth north of $22 million!
That’s what happens when you compound your money at higher rates.
And now, thanks to a new tech startup, there’s an easy way for you to take advantage of this “trick”…
Einstein Would Have Loved this App
The startup I’m referring to is called Snowball Money.
Snowball is aiming to disrupt the traditional banking and investing industries.
Essentially, it helps you grow your money at higher rates than you’d earn at a bank.
You see, a traditional bank accepts your deposits, and in exchange, pays you a small amount of interest. It then loans out your money to others at a higher interest rate than it pays you. That’s how it makes money for itself.
Accepting deposits and processing loans is expensive for banks, so they tend to pay low rates of interest. For example, Citibank pays just 0.03% to 0.04%.
But with Snowball, it’s a different story:
You see, Snowball doesn’t work with cash… instead, it works with crypto-currencies.
Because cryptos are more speculative, Snowball charges higher interest rates than banks.
Furthermore, because its business is 100% electronic, it’s much more efficient. That’s why the company can share more of its interest with you.
In fact, instead of earning far less than 1% at a traditional bank…
With a service like Snowball, you could potentially earn interest rates north of 10%!
Based on what you just learned about compound interest, which would you prefer?
But it Gets Even Better!
But here’s where this gets even more interesting…
Not only could you earn double-digit yields by shifting some of your savings to Snowball…
But this company could help you earn big returns in another way, too.
You see, Snowball is currently raising a funding round for its business. And for as little as about $100, you could claim a stake in it.
So if Snowball gets bought out in the future, you could earn even more profits.
But an investment like this doesn’t come without risks…
So, let’s quickly review some of the pros and the cons of an investment.
The Pros and the Cons
On the “pro” side:
Crypto banking is a big, fast-growing market. It’s grown from $150 million in April 2018, to $1.2 billion in February 2020.
Over 220,000 users have signed up for Snowball’s soon-to-be-announced launch.
As cryptos go mainstream, this company could be a target for a takeover — which could lead its early investors to big, quick gains.
On the “con” side:
Cryptos are still an “emerging” sector and can be volatile.
Snowball isn’t a registered bank. So its deposits aren’t FDIC-insured.
Since the product isn’t live yet, we don’t yet know exactly how it will perform.
How to Invest (and Protect) Yourself
And if you do decide to invest, please remember:
When it comes to startup investing, the key to success is diversification.
So, over time, be sure to invest small amounts into many different startups.
That way, even if some of your investments don’t work out as planned, you’ll still have plenty of chances to earn big returns!
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The Power of Compound Interest and Why It Pays to Start Saving Now
Have you ever wished that you could have more money, without all the effort? Or are you concerned you won’t have enough saved for retirement or your child’s education?
Luckily, there’s actually a simple way to accomplish those things if you’re willing to learn how to put your money to work for you. It’s called compound interest, and it can help you exponentially grow your wealth.
What Is Compound Interest?
When people think of interest, they often think of debt. But interest can work in your favor when you’re earning it on money you’ve saved and invested.
Compound interest can be defined as interest calculated on the initial principal and also on the accumulated interest of previous periods. Think of it as the cycle of earning “interest on interest” which can cause wealth to rapidly snowball. Compound Interest will make a deposit or loan grow at a faster rate than simple interest, which is interest calculated only on the principal amount.
Not only are you getting interest on your initial investment, but you are getting interest on top of interest! It’s because of this that your wealth can grow exponentially through compound interest, and why the idea of compounding returns is like putting your money to work for you.
Why It’s Important to Save Now
The magic ingredient that makes compound interest work best is time.
The simple fact is that WHEN you start saving outweighs how much you save.
An investment left untouched for a period of decades can add up to a large sum, even if you never invest another dime.
Let’s see how compound interest works with an example. Below, Alice, Barney and Christopher experience the exact same 7% annual investment return* on their retirement funds. The only difference is when and how often they save:
- Alice invests $5,000 per year beginning at age 18. At age 28, she stops. She has invested for 10 years and $50,000 total.
- Barney invests the same $5,000 but begins where Alice left off. He begins investing at age 28 and continues the annual $5,000 investment until he retires at age 58. Barney has invested for 30 years and $150,000 total.
- Christopher is our most diligent saver. He invests $5,000 per year beginning at age 18 and continues investing until retirement at age 58. He has invested for 40 years and a total of $200,000.
(Click for larger image)
Barney has invested 3 times as much as Alice, yet Alice’s account has a higher value. She saved for just 10 years while Barney saved for 30 years. This is compound interest: the investment return that Alice earned in her 10 early years of saving is snowballing. The effect is so drastic that Barney can’t catch up, even if he saves for an additional 20 years.
The best scenario here is Christopher, who begins saving early and never stops. Note how the amount he has saved is massively higher than either Alice or Barney. Is it so astounding that Christopher’s savings have grown so large? Not necessarily – what is most remarkable is how simple his path to riches was. Slow and steady annual investments, and most importantly beginning at an early age.
Compound interest favors those that start early, which is why it pays to start now. It’s never too late to start — or too early.
If you are early in your career, it can feel like there are a lot of things competing for your money between student loans, saving for a house, retirement and more. However, saving now can give you a huge edge on your finances so you can retire stress-free. Also, if you are saving for your child’s education, the power of compound interest surely applies. Start saving when they are in diapers and not as they are starting their college search.
If you want to easily accumulate wealth and take advantage of the magic of compound interest, it’s important to start early and be consistent. As you can see in the example above, it’s possible for your money to grow to a large sum with a small initial investment. If you consistently save and invest, you’ll have a nice nest egg by the time you retire.
To get started, you can:
- Max out your Roth IRA ($6,000 limit in 2021 and $7,00 for age 50 and older)
- Contribute to your employer-sponsored 401(k), especially if there is a match (that’s free money!)
- Contribute to an account like a SEP IRA if you’re self-employed; while you may not get a match from an employer, these contributions are tax-deferred
- If education is your goal, max out a Coverdell IRA ($2,000 limit) or contribute to a 529 plan (limits vary by state but are much higher).
The key is to start now and contribute what you can! It may seem like it’s not worth it, but even small contributions of $25-$100 per month add up over time.
Time is your best friend and the one thing that makes compound interest so effective. Saving now and starting early will pay dividends in your future and help you accumulate extra money. That’s the power of compound interest and why it pays to start saving now.
*A 7% annual return is hypothetical. Past performance is no guarantee of future results. (Even if the hypothetical annual return was reduced, the outcome would still be the same. Alice would still have more savings than Barney, and Christopher would still have the most savings available.)
Windgate does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation.
Data here is obtained from what are considered reliable sources as of 1/28/2021; however, its accuracy, completeness, or reliability cannot be guaranteed.
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You have probably heard about compound interest, and might even feel you understand the notion of compound interest quite well, but since it is the key concept in some of the next steps and because the impact of compound interest over time might be far bigger than you realize, this entire step is dedicated to looking at how compound interest works.
In finance compound interest is one of the most powerful factors at work that by using time as it catalyst, can do one of two things:
- keeping you poor by losing money on outstanding debts
- making you richer by making more money with the money you already have
Let’s look at how compound interest works and how it generates this power over time.
When people or organizations borrow money they are often charged interest until they have paid back their loan. Say you borrow $1000 from the bank then you pay the bank interest on top of the original $1000 you are due to pay back. If you lend somebody or an institution money, you receive money on top of the money they are repaying. (This is essentially what happens when you have a savings account with a bank: you are lending your money to the bank and therefore receiving interest).
Compound interest is interest that is accumulated from interest over interest over interest over interest.. and so on. This happens because any interest isn’t just calculated over the orignal loan, but also on any interest received up til now. Every new year that therefore adds a little more over which to calculate more interest.
Imagine you have $100 in your bank account and you receive an annual interest rate of 5%. That means that after 1 year you get 5% over your $100 added to the $100, making it a total of $100 + $5 = $105. Now let’s say you don’t touch your money at all and leave it in that bank account for another year. After that second year, you again receive 5% interest. This time you don’t get 5% over $100,-, but over your current value of $105. That basically means you get 5% over your original $100 and another 5% over the $5 that you received last year as interest. This year you therefore get $5,25 added to your bank account, leaving you with a total of $110,25. The year after you receive $5,51 in interest, and after the 4th year $5,79. As you can see, each year the amount you receive increases compared to the year before, as your balance also increases. After 5 year the account would have over $127 in it, after the 10th year it would be more than $162 and after 25 year this amount would have grown to $338. Not bad for a starting balance of $100!
Now let’s say that instead of leaving the $100 in the account without doing anything with it for 25 years, you are actually able to save $100 each year and you put that money in this account. The following with happen to this money if we get the same 5% each year: After 1 year, when you have saved up $100, it would be the same as in the example above: you’d get 5% interest, so $5, making it a total of $105. After 2 years however, you’d have saved another $100, so you now have $205 in your account. When you get your 5% interest, you now get $10,25, making it a total of $215,25. The year after you would get $16 interest, and after 5 years, you would have a total of $580 in your account. After 10 years this would have grown to $1321 and after 25 years the amount would now be $5011.
The interesting fact in this second example however is that after 25 years you would have paid only $2500 ($100 each year), but your capital would have more than doubled! And that, my friend, is what is known as the power of compounding interest.
If we take it even further and say that instead of paying $100 per year, you are able to save $100 per month, after 25 years you would have paid $30.000, but your balance would be just over €60.000. We can go on about this for quite a while, but I hope you more or less get the point 🙂
Unfortunately the above isn’t always as rosy as it might sound, for two reasons. First of all at the time of writing, interest rates are far below the 5% I mention here. The reason for this is that during financially healthy times, interest rates are usually higher, during a recession or low financial growth, the interest rates tend to drop, in order to encourage people to borrow more money, thereby stimulating the economy. Hopefully we will soon see an improved economy with improved interest rates again, but for now we are stuck with historically low rates that are close to 0%.
A second reason why the accumulated money might not be as fantastic as it might appear now, is that due to inflation, money loses its value over time, meaning you can buy less for the same amount of money.
Bearing these two factors in mind, as long as the interest you receive is higher than the inflation rate, you are still better off and making money with the money that you have in a savings account that gives you interest.
Now let’s move on to what to do with this information.
Step 20 – Compound interest – in detail
- It’s a short and sweet action plan today, which will get us ready for later steps.
- Look at all the debts that you put together in step 4 and check you have all the interest rates on each outstanding debt listed.
- Put together a list of any savings accounts that you have and find out the interest rate that you are receiving on them at the moment.
- If you want and enjoy playing with numbers, go ahead and do a search on the internet for interest calculators, and play around with the amount of money you might be able to make with current interest rates and an amount of money you have in your savings account.
Unfortunately compound interest doesn’t just have a positive effect on your finances by giving you interest on savings money, it can also have a negative result in the form of interest that you need to pay on outstanding loans. We will look at this in the next step.
The thing with compound interest is simple: it can either make or break your financial future. That might sound like an exaggeration but it really is that powerful. Today’s challenge is to learn (or refresh your knowledge) about compound interest and see where you have compounding interest affecting your finances positively or negatively.
Compound interest is nothing more than interest over interest over interest. When this happens over any savings or investments you have, this is generally a good thing as it means your capital is growing more each year. Instead of receiving interest over your original amount, you also get interest over any interest you have generated in past years. In this way if you have an investment account with an 8% annual return and an initial starting amount of $10,000 that amount will be worth $46,000 after 20 years.
The opposite happens when you are paying interest over any outstanding debts: Even though you might be paying down your loan, every month the loan provider will calculate interest over the remaining outstanding amount, meaning that you keep being charged interest over interest. This is the way compound interest can break you: if you have an outstanding loan of $10,000 at an 18% annual (1.5% monthly) interest rate, and if you are paying off $200 a month, you will end up paying a total of more than $18,000 back.
With that information in mind, find a moment today to identify how compound interest is affecting your finances: for any of your outstanding loans find out how much the annual interest rates are and find an online debt calculator to help you figure out what that means practically in terms of how much interest you will be paying back over the lifespan of each of your loans.
Then work out the annual interest you are receiving on any savings or investments and how much this is benefiting you in the long run by using an online savings calculator.
When you have done that make sure to check in our Facebook group about any shocking surprises, or use the #31DayChallengeToFE hashtag in a tweet with your update on this! To see how compounding interest works in more detail, have a look at Step 20: Learn about Compound Interest, part of the 100 steps to Financial Independence.
Financial advisors share it as a tool. Retirement accounts depend on it. Einstein called it the 8 th wonder of the world.
Compound interest is one of the most powerful tools in your financial toolbox. It’s how people grow their wealth—but you don’t need a lot of money to make use of it. With a savings account and an initial deposit, you can start putting compound interest to work for you.
With compound interest, the interest you earn on your savings grows exponentially year after year, allowing you to start with a modest amount and end up with a substantial retirement fund or savings decades later. The key ingredient is time.
Here’s what you need to know to make compound interest work for you.
Compound vs. simple interest
Interest is the money your financial institution pays you to store your money in a savings or retirement account. It’s calculated as a percentage that’s typically paid annually, although in some cases it can be paid quarterly or even monthly, depending on the account.
There are two types of interest: simple and compound. To understand the difference between them, it’s important to differentiate between your principal and your account balance. Your principal is the amount of money you’ve deposited into your account, separate from the interest you’ve earned, while your balance is the total amount of money in your account, including interest.
For example, if you deposited $100 and earned $5 in interest, your principal is $100 while your balance is $105.
Simple interest is calculated based on the principal, or the amount you deposited.
Compound interest is calculated based on your total balance, including interest you’ve already earned.
When choosing the right type of savings account for your needs, make sure you understand what type of interest the account pays. Most savings accounts, certificate of deposits (CDs) and individual retirement accounts (IRAs) earn compound interest, but it’s always best to check.
How compound interest works
What does compound interest look like in action?
Let’s say you deposit $200 into a savings account that pays 5% annual interest. At the end of the first year, you’ll earn $10 in interest, bringing your account balance to $210.
Now here’s where things get interesting.
An account with simple interest will only pay interest on your deposit, or principal, which means you’ll keep earning just $5 each year unless you deposit more funds. An account with compound interest will also pay on the interest you’ve already earned. At the end of year two, you’ll earn 5% of $105, or $5.25. The next year, you’ll earn $5.51. As long as you don’t withdraw any funds, your annual dividend will continue to grow year after year, causing your account balance to build up.
For a more visual explanation of compound interest, check out this video from Investopedia.
How to make compound interest work for you
To take advantage of this powerful financial tool, there are three simple things you need to do:
- Start early. The real magic of compound interest happens over time. The longer you let your money sit, the more your interests—and your balance—will grow.
- Make regular deposits. Adding to your account each month will help boost your interest payments even further.
- Leave the balance untouched. For compound interest to work, you need to make sure the interest gets deposited into your account and added to your balance.
Whether you’re planning for retirement or saving up for your next big purchase, compound interest can help give you a boost. All you need to do is open an account like Remarkable Checking or an IRA and start saving today.
Savings instruments in which earnings are continually reinvested, such as mutual funds and retirement accounts, use compound interest. The term compounding refers to interest earned not only on the original value, but on the accumulated value of the account.
The annual percentage rate (APR) of an account, also called the nominal rate, is the yearly interest rate earned by an investment account. The term nominal is used when the compounding occurs a number of times other than once per year. In fact, when interest is compounded more than once a year, the effective interest rate ends up being greater than the nominal rate! This is a powerful tool for investing.
We can calculate the compound interest using the compound interest formula, which is an exponential function of the variables time t, principal P, APR r, and number of compounding periods in a year n:
For example, observe the table below, which shows the result of investing $1,000 at 10% for one year. Notice how the value of the account increases as the compounding frequency increases.
|Frequency||Value after 1 year|
A General Note: The Compound Interest Formula
Compound interest can be calculated using the formula
- A(t) is the account value,
- t is measured in years,
- P is the starting amount of the account, often called the principal, or more generally present value,
- r is the annual percentage rate (APR) expressed as a decimal, and
- n is the number of compounding periods in one year.
Example 7: Calculating Compound Interest
If we invest $3,000 in an investment account paying 3% interest compounded quarterly, how much will the account be worth in 10 years?
Because we are starting with $3,000, P = 3000. Our interest rate is 3%, so r = 0.03. Because we are compounding quarterly, we are compounding 4 times per year, so n = 4. We want to know the value of the account in 10 years, so we are looking for A(10), the value when t = 10.
The account will be worth about $4,045.05 in 10 years.
Try It 7
An initial investment of $100,000 at 12% interest is compounded weekly (use 52 weeks in a year). What will the investment be worth in 30 years?
Example 8: Using the Compound Interest Formula to Solve for the Principal
A 529 Plan is a college-savings plan that allows relatives to invest money to pay for a child’s future college tuition; the account grows tax-free. Lily wants to set up a 529 account for her new granddaughter and wants the account to grow to $40,000 over 18 years. She believes the account will earn 6% compounded semi-annually (twice a year). To the nearest dollar, how much will Lily need to invest in the account now?
The nominal interest rate is 6%, so r = 0.06. Interest is compounded twice a year, so k = 2.
We want to find the initial investment, P, needed so that the value of the account will be worth $40,000 in 18 years. Substitute the given values into the compound interest formula, and solve for P.
Lily will need to invest $13,801 to have $40,000 in 18 years.
Try It 8
Refer to Example 8. To the nearest dollar, how much would Lily need to invest if the account is compounded quarterly?
How would you love to invest your money and let it grow limitlessly in 2021?
Sounds like a plan, right?
In this article, I will show you 6 easy ways to earn compound interest daily on your money.
Think of it as letting your money work for you while you reap the benefits.
If you don’t already know, compound interest is the secret ‘sauce’ the richest 1% deploys to multiply their net worth.
- Register on the platform
- Complete the interactive tutorial
- Choose one of the strategies
- Practice using a demo account
- Make a deposit and become an expert
Well, compound interest is the interest on a deposit or a loan.
Unlike simple interest, compound interest is calculated based on both the accumulated interest and that initial principal.
Think of it as the ‘interest of the interest and the interest of the principal investment.’
Do you see the big picture now?
- Register on the platform
- Complete the interactive tutorial
- Choose one of the strategies
- Practice using a demo account
- Make a deposit and become an expert
That is the secret you need to grow your money at an accelerated rate than the simple interest which only takes into account the initial principal amount.
Say you have KES 10,000 in a savings account that earns 5% interest annually.
In one year, you would earn KES 500, giving you a total of KES 10,500.
In two years, you will have earned 5% on the larger balance of KES 10,500 giving you KES 11,025.
What happens if you leave that for 10 years at the same compound interest rate?
You will end up with KES 16,470.09. That is a growth of at least 6K in 10 years!
- Register on the platform
- Complete the interactive tutorial
- Choose one of the strategies
- Practice using a demo account
- Make a deposit and become an expert
See the magic power of compound interest?
Now, what if it was compounded daily?
Here are some ways you can earn compound interest daily in 2021.
Certificate of deposits
What is a certificate of deposits?
Also commonly known as the CD, a certificate of deposit is a special kind of savings account.
You deposit your money into this savings account and promise (agree) not to make any withdrawals for a specific period of time.
Once that period elapses, you get your money back plus all the interest it accrued over that period.
How to get started with a certificate of deposits kinda investment.
You may consider taking this investment opportunity if you have some cash lying around that you won’t need for some years to come.
Maybe you want to save to buy a car, a new home, or for that vacation.
In such a case, you would be better off staying away from the stock market or bonds because you can lose the money within that period.
Or maybe you want some portion of money stacked away safely in a conservative environment away from the madness and volatility of the stock market, then a certificate of deposit is your option.
To get started, virtually every bank and credit union offers this investment opportunity.
As such, you can take a walk to your nearest bank branch and ask to look at their terms of offers.
High-interest savings accounts.
Also known as high-yields interest accounts, this is a type of deposit accounts you can find both online and in your local bank branch.
Unlike the typical savings accounts, the high-interest savings accounts often come with attractive interest rates and better returns.
So what’s the catch?
Well, to keep earning significantly, you are required to keep your savings account and checking accounts at different institutions.
If you are used to operating both accounts from the same bank, this will definitely feel awkward at first.
But thanks to the availability of electronic transfers between banks, you can easily and swiftly move your money from bank A to bank B.
If you are considering this easy way to earn compound interest daily, here are some tips to get one:
- The interest rate – are the rates you are given the standard or just for promotional purposes? You should understand it because the latter will be available for a specific period.
- How much money is required to open such an account? Are you comfortable with it?
- Minimum balance required
- Are there any fees for running the account? How can you avoid it? For example, keeping your account balance above the threshold.
This is one of the best and easy ways to earn compound interest daily.
It is a type of fixed income instrument representing a loan made to a borrower (mostly the government or company).