Posted On 05 March 2010 by on Finance Fridays, Mom Stuff

compound interest

We, as Parents, have a huge responsibility to teach our kids about MONEY.  If we don’t teach them no one else will – or they will learn from someone who has different life values than the ones you would like your children to have.

I think the most important lesson that we can teach our kids is the power of COMPOUND INTEREST.  Here’s a quick example that you can sit down and discuss with your American Girl today.  This year Emily did a lot of work for Emily Rose.  She designed outfits, she writes, produces and edits Emily Rose TV, plus we use her image, stories and likeness throughout our websites.  We decided that in exchange for all of that work she should be compensated.

On the advice of a good friend we opened a Roth IRA account at the end of the year in Emily’s name and deposited $4,800 (roughly a $100 a week paycheck after payroll taxes and such).  If we don’t ever pay her again and she doesn’t touch that money until she is eligible to withdraw it penalty free at 55 – that $4,800 will be worth $58,802.18 at a conservative 6% interest rate… all because of the power of compounding.  If we are able to continue contributing to her Roth IRA until she is 18 (granted that’s a big IF :-)) and then stop at 18 (6 years from now) – at 55 her Roth IRA will be worth $295,145.73… Whoa!  Listen to this… if Emily decided to take our money lessons to heart and after she turned 18 she continued to deposit $4,800 a year until retirement, at age 55 she would have over $1.5 Million dollars!

Now I understand that $4,800 is a lot of money and I don’t expect that we will be able to be disciplined enough to find/save that amount every year.  But the lesson is what is important here. Even if you only put $500 a year ($42 a month) in to an investment vehicle in your child’s name – that child would still have $38,430.43 at retirement age.  If you would like to use a fun calculator to illustrate this concept for your kids – you can find one here.

Of course don’t forget the dark side of compound interest – please, please teach your kids the most important lesson which is the inverse of the one above.  Credit cards are compound interest nightmares.  If Emily were to have purchased her favorite $100 American Girl Doll on a credit card at age 7  and only paid the minimum until she was 18 – that doll would have cost her $422.62 at an average credit card interest rate of 14%.  If she waited until retirement to pay for it it would cost $36,367.91 (there goes her first paycheck savings!)  Eeek!

Disclaimer – I am in know way, shape or form a financial expert – all of the information contained here is estimated and based on my own calculations which may or may not contain errors.  It’s the concept that’s important – so if you send me comments fixing my math I will cry (it never was my best subject).  Also this is in n way to be construed as investment advice!

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