Ah, compound interest. It’s one of the most important money lessons that students can learn while they’re young—but it’s also one of the trickiest topics to teach. And if we had to guess, your class list is a mixed bag of personalities and learning styles. What works for one student might not work for another! So let’s walk through a few different ways to break it all down.
What Is Compound Interest?
Before we jump in, let’s do a quick rundown of compound interest. When you put money into a savings account at a bank, it grows. This is because the bank pays you a fee so they can use your money to do business (with lots of rules and regulations to make sure you don’t lose your money). This extra growth is called interest!
Teach your children wise money habits early so you change their lives forever.
After a period of time, with the principal (the original chunk of money you put in) and the interest that your money earned, you end up with a larger total amount than you started with. And if you leave the money alone, you’ll earn interest based on that new, larger total—that’s called compound interest. This process keeps rolling, and slowly over time your money really grows, without any work on your end. Compound interest is essentially free money!
But there’s a catch. Compound interest works in your favor when you’re saving or investing money, but it can also work against you. For example, if you were to borrow money by using a credit card or taking out a car loan (of course, we know you’d never do that!), you’re required to pay interest on that money. So you’ll end up paying much more than you originally borrowed! Not cool.
The Magic of Compound Interest
So, what’s the secret weapon that gives compound interest its power? Time! It won’t work if you quit early, so fight the urge to withdraw your savings or investments before they have time to grow. And if students can just learn to delay gratification and flex those patience muscles, they’ll find that their money will ultimately do the work for them.
Ways to Explain Compound Interest:
How can you help this lesson hit home for your class? Well, you know your students, and we know personal finance. So here are five possible ways we recommend explaining compound interest so it sticks with your students for life!
1. Tell a story.
People are hardwired to remember stories. They can make a big impact when it comes to teaching complicated topics.
In his book Good to Great, author Jim Collins uses a flywheel metaphor that illustrates compound interest in action. He says to picture a massive metal flywheel—a heavy disk mounted on an axle. To get the flywheel spinning, you give it your best push forward, but it doesn’t move much. You can barely even notice that it moved! It takes you three whole hours to get the flywheel to do just one complete turn. But as you keep pushing, you start building up a little momentum. You move it around a second rotation, and then a third.
You keep pushing in a consistent direction, and eventually—it’s going! It has picked up enough speed that its own weight continues hurling it forward, without you needing to push. Each turn of the flywheel compounds on the one before it and creates unstoppable momentum.
So, which push caused the flywheel to go so fast? The first? The fifth? Actually, it wasn’t one push but all of them together that got the flywheel moving. This is what happens when you invest consistently over time. The accumulation of your efforts will create momentum that you can hardly keep up with!
2. Do an activity.
Compound interest is all about delayed gratification and patience, as your students will see in this activity. Start by asking your students, “Would you rather start with a penny and double your money daily for 30 days or have $1 million?” They might be tempted to take the $1 million right off the bat, but challenge them to figure out which option will make them wealthier in the end. Have them pull out a pencil and paper and do the math!
Have each student start at 1 cent and double it 30 times. At first, things aren’t looking impressive. They’ve only just made it past $1 at Day 8. Even halfway through the month, they’re still only at $163! At Day 25, they might be wishing they had taken the $1 million, since they’re still just at $167,772 and the month is almost over. But if they keep going, this is when the magic starts to happen. (Remember, our secret weapon is time.)
Suddenly, the small progressions made throughout the month start to pay off. On Day 28, they’ve surpassed $1 million with a whopping $1,342,177. Keep going and watch your students be amazed at how much they end up with after 30 days! Their results will look something like this:
Day 1: $.01
Day 2: $.02
Day 3: $.04
Day 4: $.08
Day 5: $.16
Day 6: $.32
Day 7: $.64
Day 8: $1.28
Day 9: $2.56
Day 10: $5.12
Day 11: $10.24
Day 12: $20.48
Day 13: $40.96
Day 14: $81.92
Day 15: $163.84
Day 16: $327.68
Day 17: $655.36
Day 18: $1,310.72
Day 19: $2,621.44
Day 20: $5,242.88
Day 21: $10,485.76
Day 22: $20,971.52
Day 23: $41,943.04
Day 24: $83,886.08
Day 25: $167,772.16
Day 26: $335,544.32
Day 27: $671,088.64
Day 28: $1,342,177.28
Day 29: $2,684,354.56
Day 30: $5,368,709.12
3. Make it practical.
Sometimes it takes real-life application for a concept to click. Try comparing compound interest to a personal habit that your students will connect with (like reading 10 pages of a book a day or saving $50 a month) to show how small actions seem insignificant in the moment, but they really add up over time. They’re easy to do but also very easy not to do. Let’s use working out as an example.
We’ve all been there: It’s January 1 and you commit to getting fit in the new year. You start out super motivated, working out for an hour and a half every single day. It’s going great for two weeks until you realize you’re not seeing any results. You get discouraged, stop exercising altogether, and pretty soon are back where you started. You need a new plan!
With compound interest, slow and steady wins the race. So instead of sprinting out of the gate, imagine you start to exercise for just 30 minutes a day and eat healthier. At first, you don’t see any results (and you’re always sore!), but you decide not to give up. After a few weeks, you still don’t see much progress, but you suddenly have more energy. So you keep it up. As your clothes slowly start to fit better and you notice more muscle tone, you’re excited about the small changes you see.
This fuels your motivation. Your short workouts, newfound energy, internal motivation and healthier diet all add up (slowly over time) until one day you look in the mirror and realize you’re stronger and healthier than ever. The key? You didn’t quit! It was only a little bit of effort every day, but consistency and time brought you amazing results. Much like compound interest, getting physically fit is a marathon, not a sprint.
4. Play a game.
One surefire way to guarantee student attention is to involve food! This marshmallow game can be played throughout the duration of your class period to illustrate compound interest. It’s easy, and all you need is a bag of mini marshmallows (you can also use M&M’s, Skittles or any other small candy). Here’s how to play:
Give each student one marshmallow. Throughout the class period, compound that marshmallow every 10 minutes by giving double the previous amount to everyone who hasn’t eaten theirs yet. For example, after 10 minutes, whoever hasn’t eaten their one marshmallow gets one more (if they already ate it, they don’t get another). In 10 more minutes, give two additional marshmallows to everyone who hasn’t eaten theirs yet (now they should have four).
In 10 more minutes, give them four more, then eight more, then 16 more, and so on. One marshmallow didn’t seem like much at first, but if they can resist the urge to eat them, they should have 32 marshmallows to devour at the end of one hour-long class period. (Just make sure you have enough marshmallows to give out!)
5. Work a real-life problem.
Avoid the question every student loves to ask: “When will I need this in the real world?” Have your students solve this everyday math problem to see compound interest in action.
Bobby made a one-time deposit of $500 in a savings account with a 10% interest rate. Using the formula FV=PV(1+ r/m)mt, figure out how much Bobby will have in his savings after 20 years if he leaves his money in the account and lets it grow. Have your students pull up the activity in Chapter 3, Lesson 6 to help them solve this problem! (Answer: He would have $3,363.74.)
See? Compound interest doesn’t have to be confusing! Our hope here at Ramsey Education is that these creative explanations and activities will help make this concept easier for you to teach and easier for your students to understand. And once it clicks, your students will understand a big part of wealth building and the importance of time and patience when it comes to investing.
For more information about teaching financial literacy, visit us at ramseysolutions.com/education.