Tuesday, December 29, 2009

Teaching Your Kids Compound Interest Fu

I love movies. I especially love movies that come from left field and are simply awesome. For me, The Matrix was that type of movie.

The idea that we are all human batteries, living life in an imaginary world is creepy. However, being able to download any type of learning into the brain was the stuff of Cyberpunk. I loved it.

There is one scene where the main character, Neo, awakens after having martial arts fighting skills downloaded and exclaims “I know Kung Fu.”

Let’s teach our kids about compound interest.

“But Chuck,” you say, “There are so many other things I need to teach the kids, and I am sure that they will learn all of this in High School Economics. I don’t even understand it myself.”

Raise your hands out there if, at anytime in your adult life, you have uttered this phrase “I wish I would have started this when I was 20.”

Ok, now that I have lowered my hand, I can keep typing.

Make it Real

I love reality shows. This is the first year that we let the kids watch Survivor with us, and they were amazed that you could actually win a million dollars.

Did you know that most millionaires in America are “First Generation” rich? They did not win it on an Island, they did not hit the lottery – they did a lot of little smart things over a long period of time.

Booyah, as Russell might say.

What is Compound Interest?

Very simply put, it is magic. Seriously. If I was to take five dollars and put in in the cookie jar every day, I would have at the end of the year $1825. You can simply multiply 365 times $5.00. You can then multiply that out by the numbers of years you plan to invest in the cookie jar.

Instead of putting it in a cookie jar, let’s put it into something that has an interest rate associated with it. The cookie jar has a 0% interest rate, and is a lousy investment tool.

However, a mutual fund that averages 12% since it’s inception is a very nice tool. But, what does that mean? You multiply the $1825 by the interest rate (assuming yearly interest for ease of math) and you would have an extra $219.

If you take that $219 and put it back in your investment, instead of taking it home, next year you will not have interest on $3650 ($1825 times two years), but $3869. The second year, your interest would be $464.28.

Rinse, lather and repeat. It just keeps growing.

Drinking at Five Bucks

Consider my earlier post, I picked on Starbucks Coffee because I like their product. I can easily drop two to five dollars a day on any of their drinks and not bat an eye. I simply annualized the money to show how much you could put back into your wallet for the sake of increasing cash flow.

Taking my previous example, instead of putting five dollars a day and calculating interest on an annual basis, let’s do real world. You would normally save that five dollars and invest it on a monthly basis. In addition, interest is calculated on a monthly basis, not an annual basis.

So, let’s invest $150 a month between age 16 and 76. Working a part time job, do you think they could save $150 a month (hint…yes)?

Total Money Invested


Total Interest Earned


Total Future Value


$1,000,000 Year


Age your sixteen year old will be in 2046


You can play around with these numbers using any financial calculator. The reality of the stock market is that we have bear markets (when stock market is down 20%) and bull markets. That’s why the age of your investment tool and the average rate it has returned since inception is so important.

And…what if I am half wrong?

I Only Wish…

Seriously, I wish that I had known this when I was sixteen. I got my first job at eighteen working at a gas station and then moved into ushering theaters. I was making minimum wage and could make more than $150 a month. I had some friends throwing boxes at UPS and the rumor was that these guys made great money.

The thing about compound interest is that it is a slow cook over time. Time is your enemy. An early start changes everything.

Even, possibly, changing your family tree.

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