This is a quick lesson to teach your kids about compounding interest and hopefully get them interested in investing their savings.
The summer after 7th grade, I went to a math camp where they taught us a fun trick to pull on our parents, and it was called the “Penny Commission Plan.” It taught us about compounding interest and exponential curves. Once you finish reading, have your child try and trick the other parent, and watch the fun happen.
The goal is to have your child sign a contract with the other parent, and there are only four rules:
- The contract lasts two (2) years.
- The child will complete all chores the parent assigns during those two years.
- The child will start out with a monthly salary of one penny ($0.01).
- The child’s salary will double every month.
When explaining this, be sure to talk through the first couple of months of salary so they understand how it works.
Example: The first month, they will be paid one penny ($0.01). The second month, they will be paid two pennies ($0.02). The third month, they will be paid four pennies ($0.04). And so on.
What Will Probably Happen
I have taught this to high school and middle school students. At first, they all think I’m insane. All they hear is that they do all these chores…for pennies. Not worth much, right? Well, after the students have decided this is a stupid idea, I like to hand out a piece of paper with the table shown here. Just look at the 24th month:
Wait, what?! The 24th paycheck is $83,886.08? Yes, that is growing at an interest rate of 100%. If you were to draw a line, it would look like this:
Now, have them go try and trick your spouse or significant other. This should be good.
Continuing the Lesson
If you child becomes more curious, you can teach them that an interest rate of 100% is extremely difficult (read also: impossible) to achieve, but as long as you have a positive interest rate—whether it’s 3%, 5%, or 10%—it makes an exponential curve. Check out the graph below:
Be sure to point out that with a higher interest rate, your money grows faster.
For the Skeptics
“But Dan, that’s not how real life works.”
Although the stock market has its up’s and down’s, check out the history of the S&P 500 starting in 1957. See how it curves upward over time?