John David Kromkowski learned about compound interest as a youngster with the help of a passbook savings account at the bank.
“Every time you went in, they would calculate the interest for you and put it in the book,” the 49-year-old Baltimore County lawyer recalls. “It made me feel like, ‘I’m making money here.’ “
Kromkowski wants his son to learn about the miracle of compounding — earning interest on interest. The problem: Savings accounts pay so little interest now that compounding is negligible.
Kromkowski’s son, Simon, deposited $500 of inherited money a few months ago into a Bank of America savings account that pays an annual rate of 0.04 percent. The first month’s interest: one penny.
Most Read Business Stories
- REI to sell its never-used Bellevue headquarters and shift office work to multiple Seattle-area sites
- Why did it take more than 2 months to stop the largest fraud in Washington state history?
- Boeing deliveries slow to a trickle, while 737 MAX cancellations grow
- Seattle-based cookware chain Sur La Table sells for around $90 million
- Apple’s stock split should put a focus on numbers that truly matter
“I think it’s kind of stupid. You put lot of money in it, but you don’t get anything,” the 11-year-old said.
Still, compound interest is an important concept; the earlier it’s learned, the better. Money you put away in savings earns interest that is added to the principal. Then you earn interest on that, and savings build faster.
Compound interest, though, works against you when you borrow. Interest accrues on the debt over time, and you can end up owing much more than you borrowed.
Savings accounts also remain a valuable teaching tool, despite today’s dismal interest rates. Children with bank accounts can learn to become disciplined savers by watching their balance grow with each deposit.
Here are a few tips for parents wanting to teach the value of compound interest:
• Shop around: You’re not going to find a financial institution paying a generous interest rate, but you can find places that offer more than 0.04 percent.
Credit unions, for instance, tend to offer higher rates on deposits than banks. You can also find more generous rates at institutions farther away if you’re willing to bank online.
Sallie Mae Bank, for instance, offers savings accounts with an annual percentage yield of 1 percent that’s compounded daily. On a $500 deposit, the balance would grow by $5.03 the first year. Not much, but better than the 20 cents that Simon will earn.
Check Bankrate.com to find out the highest rates on savings accounts being offered in your city or nationwide.
• Parents as bankers: The experience of seeing a savings account grow with interest has a powerful impact on children, said financial economist Lew Mandell. If banks don’t provide that experience, parents can do so themselves, he said.
He suggests parents pay the interest, depositing the money quarterly in the child’s savings account. It doesn’t have to cost much.
At a 3 percent annual rate, parents would pay out a little more than $15 the first year on a $500 initial deposit.
“To make it more interesting, think of giving the child 5 percent a year,” Mandell said. At that rate, parents would pay about $25.50 the first year. After 10 years, the child’s account would grow to $821.81.
When higher interest rates return, Mandell said, parents can stop playing banker.