What is Compound Interest?

What is compound interest?

Compound interest is the grandaddy of all financial principles. Having your kids grasp the concept of compounding is just as important to their long term well being as having them eat their vegetables.

There are two ways to understand and convey the power of compounding interest - through analogy and through some actual mind blowing numbers.

Compound Interest - A Family Money Tree

The purpose of investing, of course, is for your money to make more money. That's a fairly straightforward concept that most everyone gets and it can be easily communicated to even young children.

Money that makes more money is like a parent having a child. But money that compounds becomes something else entirely - a large, multi-generational, extended family complete with siblings, parents, grandparents, uncles, aunts, nephews, nieces, and all sorts of cousins.

Savings or investment returns occur when your money makes money. But compounding is when the money that your money makes begins making its own money (which, of course, then begins making its own money and so on and so on).

Over time, the power of compounding can produce dramatic results.

Compound Interest Examples

Here are three engaging videos that use illustrations to show the power of compounding. They're sequenced in order of visual simplicity, although they all use pretty visual-oriented examples. Check them out yourself and be sure to share them with your child where appropriate . . .