Learn about the benefit.

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كاتب ذكاء اصطناعي

In its original definition, interest is a payment for the use of money over a period of time. You earn interest by lending your money to the bank. In return, you pay interest when you borrow money from the bank. The rate of payment can be a fixed or variable amount over the duration of the loan or deposit.

Two examples of interest received and interest paid

When you open a savings account at the bank, the bank pays you to keep your money deposited in their bank. Interest is the amount you receive from the bank. When you take out a loan to buy a house, you pay interest to the bank for using the borrowed funds to purchase your home.

Calculating simple interest vs. compound interest

There are two ways to calculate interest on a savings account or loan. Interest can be simple or compound.

Simple interest

This interest is calculated at a fixed percentage. In the case of savings accounts, it is calculated based on the total amount of money you deposit. For example, if you deposit $100 at an interest rate of 2% paid semi-annually, you will receive $2 twice a year, making the total interest earned $4 annually. You will also see this type of interest calculation used for some types of bonds.

Compound interest

Compound interest is more exciting and complex to calculate. Here, the interest from one month is added to the total principal amount of the loan or account, and interest is earned in the following month. In other words, it is built upon with each compounding period that passes.

Let’s say the bank starts paying $2 based on the $100 you deposited. However, your next payment is based on the total amount you have accumulated in the account, which is $102. This may not seem like a significant increase, but over time, compound interest is an easy and effective way to earn money from your funds.

The amazing power of compound interest

Few children have an innate admiration for banks and saving. However, they might be interested in simple math and the power of compound interest. If you want to teach your child how they can quickly double their money without lifting a finger, ask them to calculate the answer (with your help or without it) using a tool called “the Rule of 72.”

Find the rate of earning interest. Let’s assume it’s 6%. Divide 72 by this number (72/6 = 12) and you’ll see that it will take 12 years to double your money. Start the exercise by determining the amount to be deposited. Between the money received at Christmas, personal earnings, and other sources, let’s say your 10-year-old has $3,000. Once you multiply $3,000 by 2, in 12 years, without doing anything, your child will have a doubled amount and will have a good saving of $6,000 by the age of 22.

The downside of interest

Although your child will certainly be happy to learn that they can easily earn interest, they will be less pleased to hear about the negative effects of interest that they will have to pay as adults on borrowed money. They will not only have to pay interest (on large purchases like cars and homes) but they will also be in debt with very high interest if they do not pay off their credit card debts monthly.

Now that your child understands the interest rates they can expect (rarely exceeding 5% from the bank), you may want to explain that the interest rates they could owe can be as high as 20% or more (on some credit cards, depending on credit rating and other factors).

At this point, you may want to offer the following tips to keep interest rates low:

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