Create a Family Bank to Teach About Compound Interest 🏦

There is a lot more to effective money management than an understanding of savings and interest income, but these are certainly important! So a few years ago I decided to set up "The Prentice Family Bank" for my kids (more details on how this bank operates below).

Table of Contents

Objective
Why This is Such a Difficult Lesson
Create Your Own "Family Bank"

Objective

I really don't want my kids to have to suffer through the difficulties of being in debt when they're older. In fact, I would far prefer that they save a significant portion of their income at a young age throughout their lives and are able to get to a point where they have enough savings to receive a nice chunk of interest income every month or year to help cushion their financial situation. How cool would it be if they could become financially independent? Who wouldn't enjoy that?

So many people in our society these days are in debt. Apparently 29% of Canadians have balances owing on their credit cards, which is probably one of the worst forms of debt you can have given the high interest rates. On the other side of the coin, there is an small movement of people pursing early retirement and an even larger group pursuing retirement at a normal retirement age. I imagine that a bit more education on saving and interest income directed towards 3-10 year olds would help reduce the number of people in debt and increase the number of people who are financially independent in the future.

Why This is Such a Difficult Lesson

Certain systems in our world change over time in an exponential way, and it is very difficult for us human beings to internalize how these systems work in a common sense sort of way. Linear systems, on the other hand, we have a much easier time with. The classic example is a lion is running towards you in the jungle. The time it will take for the lion to reach you is equal to the distance divided by it's speed. This is a linear formula and we are evolutionarily hard wired to immediately estimate the result, which can help us decide how best to escape.

Our common sense tends to estimate the result of exponential changes linearly too. At first, when the quantity is only increasing very slowly, we discount that it even is increasing. Then all of a sudden things get insane really quickly and each doubling period rocks your understanding of the universe (depending on the quantity in question, of course). This isn't so fun when it comes to global pandemics, superintelligent AI, or debt but it can be a bit more exciting if you learn at a young age that it also applies to compound interest.

Create Your Own "Family Bank"

I would suggest you create your own Family Bank for your kids, offering them a healthy interest rate in exchange for saving their money. Here's how I set up the Prentice Family Bank:

1. I attempted to explain interest income to my kids (if they are young, the analogy below might help).

You might of heard that money doesn't grow on trees, but it actually can grow in the right kind of banks. If you put enough money into our Family Bank, after a little while it will hatch its own baby money. When that money grows up it will also start hatching baby money. The more money you have in the bank, the faster it will grow for you.

This step will likely need to be repeated frequently for many years.

2. Any time they want to deposit money that they've earned or received as gifts, they can just hand it to me and let me know it's for the Family Bank.

3. I would recommend a minimum deposit amount to encourage them to also learn to keep track of their change until they accumulate enough to deposit it in the bank. This also helps minimize the number of deposits they make if they start searching for pennies in the couch cushions (or whatever the modern equivalent is...maybe earning Robux from a game they've developed).

4. Once they give me their money for safe keeping, I write down the date and amount they deposited. You need the date in order to calculate the interest earned since the last deposit or withdrawal. I prefer putting this info into a spreadsheet that can calculate the interest for me and keep track of the total balance. Premium subscribers of The Nerdy Parent are welcome to click here to make a copy of my template and use it for their own Family Bank. To really show the effect and to make the explanation of monthly interest versus annual interest a bit easier I've so far been offering my kids 12%/year (1%/month). I'm considering slowly reducing this as they age, but so far it's not a huge issue because they don't have that much money.

5. Any time they would like to withdraw money from their account, I either give them the cash amount or just pay for the item they need the money for directly. Then I make sure to mark down a negative amount on the spreadsheet. Google Sheets works well because it has an app that works on my phone.

In some cases I mildly discourage them from withdrawing their money. I take the approach of trying to convince them, but also try to make sure they know that it is ultimately their decision (I'm just providing advice). In order to learn the lesson of saving and growing your money, you really have to feel the regret of spending all your money on something that you end up not really using much. To truly learn this lesson, you have to have the power and control over your own money. And what better time to learn it than when they are young and only have a couple hundred dollars (or less).

This is also a great way to keep track of gifts that people give to your babies and toddlers. They will appreciate it when they're a bit older! But I don't give interest to my kids till they reach 4 years old.

Make sure to sign up for a premium membership to The Nerdy Parent to access the awesome Nerdy Parent Family Bank Template spreadsheet!