How do you explain interest to children?
Every year, the credit agency Creditreform publishes the Debtor Atlas Germany. The 2020 edition also takes a worried look at the situation of children. Of the almost 1.7 million people, for example, who use the services of the food banks in Germany, almost a third are children and young people, i.e. a total of around half a million.
Credit and debit interest, nominal and real interest, negative interest, compound interest, interest rate – many terms and a question that children are sure to ask at some point: What exactly is it? Abstract. That will be the first answer that pops into many parents’ heads. And indeed, interest rates are not easy to explain.
For this form of mathematical abstraction is generally not yet taught in primary and lower secondary schools. Only from middle school onwards, i.e. when the children are about 12 or 13 years old, is the calculation of interest on the curriculum. However, many children do not want to wait that long for a plausible explanation. After all, it sometimes affects their pocket money, for example if it is in a traditional savings book.
Interest is what falls off
To give children an age-appropriate ticket to the interest universe, parents should first limit themselves to the two most common forms of interest, i.e. credit and debit interest. After all, these are precisely the forms of interest they are most likely to encounter in the beginning.
Let’s imagine for a moment that we are Pinocchio. The rebellious puppet with all-too-human features one day becomes the victim of a cunning scam. For the Fox and the Cat persuade Pinocchio to bury his gold coins in the wishing field at midnight. They promise him that these coins will grow into a money tree overnight and that he will then be able to reap richly the next morning.
Now, of course, we know that the story ends badly for Pinocchio and he loses all his gold coins. On the other hand, the image of money bearing fruit if you nurture it (or lend it to the right people) is not so wrong. After all, that is exactly what happens with credit interest: it multiplies, shoot by shoot and fruit by fruit. The bigger the seed and the more terrible the soil, the longer the time and the fewer foxes and tomcats, the more shoots and fruit this tree bears.
What is important to convey here is that classically the bank is the proverbial soil to which we entrust – and can entrust – the money we do not need at the moment. After all, the bank does something with it similar to what the soil does with the seed: it enriches the money so that it bears the first fruits over time. It works with it, just as fertile soil does with seeds in the broadest sense.
We can determine how much money we want to “let plant” and how long the flowering should last, i.e. the term. When this is over, our “buried” money has multiplied. Thus, from an original savings amount of 50 euros, we can now buy something that costs 60 euros without having added the difference of 10 euros ourselves.
Now let’s assume that the 60 euros are not quite enough for the next exciting purchase (pony, scooter, bicycle). So as a child, you have to borrow the missing money somewhere. The nearest bank counter is just around the corner, i.e. mum, dad, grandma, grandpa or other generous relatives. If they let themselves be softened up and give 10 or 20 euros, they will not have the same amount elsewhere. Sure, mum and dad work and get a salary, so they can surely spare the few bucks. Yes, but of course only against interest. After all, it is their money that they are leaving to their child out of pocket. So if mum and dad contribute 10 or 20 euros, they could charge some kind of lending fee for it, for example 1 or 2 euros. This “compensates” them, so to speak, for not being able to buy a pony or a bicycle themselves during the time they lend this money to their child.
If the child gets this loan, he or she will have to pay back not 10 or 20, but 11 or 22 euros. Where is the money supposed to come from? Of course, from grandma and grandpa, who in turn may only charge 50 cents interest. Would that already be a childish cum-ex business or a healthily developing business sense?
Learning from borrowing
Even if you are not a friend of money-bearing flora, the image of the tree growing and bearing money fruits nevertheless conveys very vividly how money multiplies all by itself if you:
- plant it in fertile soil
- choose the right amount of seeds
- give the money time to flourish
On the other hand, when imparting knowledge on the subject of interest, it is also important to explain that you should only plant as much money as you can spare, that you should know the soil well and that you must have patience so that the harvest will be abundant.
Likewise, the topic of interest is always about dynamism, postponement or even renunciation of purchases:
- If you lend your money at interest, its quantity automatically increases. The higher the amount lent, the longer the period of lending and the higher the lending fee (interest), the more luxuriantly it grows. On the other hand, during this period you lack the corresponding amount, which can possibly lead to the fact that you can only buy the now well-known pony later, but at the latest when you get your money back plus interest.
- On the other hand, if you borrow money, you have to compensate the borrower – by paying interest. In return, however, you can afford the pony sooner. And if you take a small fee for a ride on the pony, you can also pay back the borrowed money quickly – plus interest, of course.
Simply explain the multiple
We adults know that interest is calculated as a percentage. But percentages are complicated in how they work and how they are explained. Therefore, children should first be taught about interest in whole, simple numbers, i.e., for a loan or borrowed amount of 10 euros, interest is 1 euro, for 20 euros it is 2 euros. And, of course, there is nothing to stop you from taking out your crayon and drawing imaginative percentage signs now and then.
For parents who would like some inspiration or support in matters of interest in particular or financial education in general, we recommend our Finny Kids and Finny Family App. The financial literacy challenges contained in the app teach important money terms in a simple and easy-to-understand way and are fun for both children and parents. And all this without interest, but with a lot of sense.
The Fintune Research team provides you relevant information on financial literacy for children. Learning about money at an early age helps to train reasonable money habits and avoid future debt traps.