Explaining personal finance to kids can be very challenging, especially when it comes to the logic around compounding.
Here's a simple way to explain the power of compounding with your kids. Here's how the conversation would be like between me and my imaginary son, Tom.
Mickey: Tom, what would you rather have, $100,000 or a 10 cent coin that magically doubles its value every day for 30 days?
Tom: $100,000, of course!
Let the magic begin
Now let's show Tom the difference between the 2 choices.
Here's how the first 10 days would look like:
Day 1: $0.10
Day 2: $0.20
Day 3: $0.40
Day 4: $0.80
Day 5: $1.60
Day 6: $3.20
Day 7: $6.40
Day 8: $12.80
Day 9: $25.60
Day 10: $51.20
Oh boy we that 10 cent coin was only slightly over $50 after 10 days.
Day 11: $102.40
Day 12: $204.80
Day 13: $409.60
Day 14: $819.20
Day 15: $1,638.40
Day 16: $3,276.80
Day 17: $6,553.60
Day 18: $13,107.20
Day 19: $26,214.40
Day 20: $52,428.80
Halfway there! Our 10 cent coin has grown to $52,428.80.
Day 21: $104,857.60
Day 22: $209,715.20
Day 23: $419,430.40
Day 24: $838,860.80
Day 25: $1,677,721.60
Day 26: $3,355,443.20
Day 27: $6,710,886.40
Day 28: $13,421,772.80
Day 29: $26,843,545.60
Day 30: $53,687,091.20
Here's where things get crazy. Our 10 cent coin has bloomed into $53,687,091.20!
Oh my god! We're practically millionaires swimming in money now. I bet Tom's eyeing my magical 10 cent coin now.
There's no magical 10 cent coin in this world (okay, maybe Bitcoin but look at where its price is at right now). So what's the point of this?
Well, there's a few lessons that Tom can learn here.
Compound interest is a powerful magic
At face value, it's an easy choice to have $100,000 in hand when compared to a 10 cent coin.
But when you put the 10 cent coin to work on its own to grow more money, and then having all these new money make even more money for you, I'm sure you get the picture.
It takes time to gain from compounding interests
Even magic requires time to make it perfect.
Using the example above, the first 20 days only got us half of that $100,000 that we could have gotten from the beginning. The real magic only happens in the last 10 days where that $50,000 transforms into $54 million.
Think of the days used in the above example as years. We get all excited about compounding but the excitement dies down fast in the first 10 years when we don't see the jump in profits that we expect.
Have faith in the sound investment decisions you have made and as long as the intentions and goals remain aligned, keep going.
Patience is key.
Now let's get back to the real world
Let's forget about the magical 10 cent coin (because none of us have one) and look at a real world example.
I don't have a secret investment tip to help you double your money every day. But let's say Jerry starts investing with $20,000 at 25 for retirement and decides not to add any more money to this portfolio. He invests aggressively to get 10% return from his investment each year.
Start at 25: $20,000
Jerry's little investment of $20,000 would have made him a millionaire by the age of 67! Now, think about what happens if Jerry had decided to contribute $5,000 to his retirement portfolio every year from the second year onwards.
Spoiler alert: Jerry would have become a millionaire by the age of 54 (13 years ahead of time)!
Nobody has that magical 10 cent coin but everyone has one commonality - time. Start saving when you’re young and you can spend your golden years financially independent, doing things that you love instead of frying french fries at MacDonald's (unless you really love frying french fries at MacDonald's).
This article was adapted from an article written by the brilliant folks at 1500days.com