You should pay your kids a really high interest rate on their savings. Here's why and how.

One of the main reasons I started The Parent Bank was so that I could easily teach my kids that saving also means earning. No less than Albert Einstein himself, in fact, once wisely said that "Compound interest is the eighth wonder of the world."

There are many problems with a Piggy Bank, chief among them is that a Piggy Bank filled with cash and coins doesn't earn anything for our kids. Think about how annoyed we have all been for the past few years with our banks that have paid us .1% interest on our savings. Now imagine that was (and will continue to be!) 0%. That's what kids who save cash in a Piggy Bank are stuck with.

When your savings doesn't earn, there is no reason not to spend it all right now. In fact, from a strictly Economics 101 perspective, you should spend all of your savings as soon as possible it, because you are losing purchasing power every day as inflation causes prices to rise while your savings remains the same.

So what does this mean for your family? Here's what we recommend:

1. Phase 1: Saving money magically creates more money!
When your kids first start saving, we want them to have an "ah-ha!" moment when they feel the power of the "magic money" you can earn by saving. The problem is that if you pay a "standard" rate of say, 5% annual interest, and your kids have $50 saved....then they will make about $.20 cents in a month. That's not very exciting.

So we think that, at least to start (maybe for the first $100 of savings), you should offer an "introductory" rate of 50%. This will pay them ~$2 per month on $50 - i.e. enough that they could actually buy something with that savings and get your kids excited and intrigued about not just saving money, but earning money on that savings.

2. Phase 2: Feeling out the balance between Spending and Saving
Of course you can't pay 100% forever...or you will owe your kids a lot of money very soon (compounding!). So once you reach the $100 (or whatever you decide) threshold, we will need to dial it back to something more in line with reality. The stock market has historically returned ~10% (and yes, these returns are of course highly variable, but for now we can brush that aside - your kids are very young so they don't need to worry yet about standard deviations and alpha / beta etc - that can come later!). You love your kids, so let's give them maybe another couple percent and go with something in the 12%-20% range? Then you're paying approximately $1/month in Interest for every $100 that they have saved. When you roll this out, you should have a chat your kids, and explain the basics of how investing works, and that historically, money that you invest grows more than the prices of things that you want to buy. Which means that the more that you save today, the more FutureYou will be able to buy tomorrow. But on the other hand not fair to PresentYou to just save and not buy a few things that you want or need today. Saving and spending is a balance that you will want to feel out.

These are all just guidelines - one of the main advantages of using The Parent Bank instead of a "real bank" is that you can set whatever interest rate you'd like. So feel free to experiment a bit, and let us know what works and what doesn't!

3. Phase 3: Compounding FTW!
When your kids seem to appreciate the tension between saving and spending, the next phase is to return to the the Albert Einstein quote and help them appreciate that compounding growth is indeed magical. So in this phase of learning, we focus on "zooming out" to look at how savings can grow over time through the wonders of compounding growth of your savings. And that they will earn them way more money than they will make with allowance. So at this point, our focus is less about the interest rate (which can stay whatever you set in Phase 2) and more about looking at the growth of interest, compounded over many years.

Now the mathematical reality of exponential growth that is not very intuitive for humans to comprehend and it takes practice to really appreciate. There's a great parable about the inventor of chess. A king who loved chess asked the inventor what reward he could grant him for inventing such a popular game. The inventor thought for a bit, and then he requested that the king give him one grain of rice today. And then, for the next 63 days (64 is the number of squares on a chess board) that he receive double the amount of rice from the day before. The king readily agreed, reacting simply to his instinct about how few grains of rice that is for the first several squares...only to realize over the next few weeks that the inventor was asking for more rice than exists in the world - specifically 264−1 or 18,446,744,073,709,551,615 grains which is a number so large that I'm not even sure how to write it ("quintillion"?).

You can put this in the form of a good dinner table riddle and ask your kids: a) would you rather have $1,000 today or b) a magic chess board that will pay you over 64 weeks, starting with 1 penny today, 2 pennies tomorrow, 4 pennies the next day, such that by week 64 (just over a year, you will have...more money than has ever existed in the entire world and it's not even close!  

We are working on a few Parent Bank features to help kids learn to appreciate the wonders of compounding growth so stay tuned! You can also set up a simple excel template. How much money will you have saved when you are 18? When you 30? How does that change based on how much you spend today? 

Phew that was a lot! As always, we'd love to hear your thoughts and feedback on any of this, so feel free to reach out via email or social media with the links below in the footer!