Interest is an important part of your finances, from paying off debts to saving for retirement. Knowing how earned interest works can help your child understand how to build wealth and make smart money choices as they age. But how do you earn interest? And how do you explain earned interest and investing for kids?
What is earned interest?
Earned interest is the money you make by putting your funds in a savings account or investment. Think of earned interest as the paycheck your money makes by going to work for you. Banks will pay you interest to put your savings in their accounts, and you can earn more money the longer you save. In a way, the bank becomes a borrower of your money, and you become the lender who earns interest.
How does earned simple interest work?
Simple interest is the amount of earned interest you make on your savings. As the name implies, it’s simply the amount of money you earn for putting your money to work, like a paycheck. If you withdraw your simple interest each month, your interest payments become a form of income. Kids might be interested to know they can start making their own money by saving before getting their first job.
How does earned compound interest work?
The real power of interest happens when you put your earned simple interest to work by adding it to your savings. Then, the money you earn from savings also goes to work for you. You earn interest on your interest, also known as compound interest. The longer you let your earned interest go to work, the more money you can make long-term. Compound interest is the easiest way to build wealth over time.
How are you paid earned interest?
When you open a savings account, banks state the interest rates you can earn as an annual percentage yield (APY), including compounding interest. The better the interest rate, the more money you will earn putting your savings to work.
Earned accrued interest
Banks and investments typically pay out earned interest monthly or quarterly, but you earn interest every single day. The money you earn in interest grows, called accrued interest, but you can’t use accrued interest until it is paid at the end of the period.
Savings accounts aren’t the only way to earn interest. You can also put your money to work owning shares of a business or equity interest. Some of your child’s favorite companies will pay shareholders part of their earnings regularly, called dividends.
Earning interest and investing for kids
Savings accounts and investing opportunities are great options to teach your kids how to earn interest depending on your savings goals. Help your child start saving by setting smaller goals to practice. Get kids engaged by helping them set customized savings goals through the GoHenry app for anything from a new game to their first car. Automate a weekly savings amount from a kids debit card to create a habit of saving and putting their money to work toward future goals.
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