Compound Interest

In this personal finance lesson, students will compare simple and compound interest on savings.

Warm-Up

Use the Compound Interest Slides to present this lesson. Slide 1. Ask students if they have heard the term “compound interest”. Have them identify what they know about compound interest, how it could help them, or how it could hurt them financially. (Accept all answers without giving them the definition or evaluating their answers.) Slide 2. Tell students they are going to watch a video and ask them to listen for how people can make their money grow. Show the video No-Frills Money Skills Episode 1. After viewing the video ask the following questions:

• What is the best plan for building your saving? (Pay yourself first.)
• What is the price people pay for using someone else’s money? (Interest.)
• What is the money deposited into a bank account that will earn interest called? (Principal.)
• Why do banks pay interest? (Because they use the deposits to make loans to other customers; the interest is their cost of using someone else’s money for the loans.)
• When was the young woman in the video better off — when she started saving early or when she waited to save? (When she started saving early.) Why? (By saving early she had a longer time to earn interest on her deposits.)
• How did she earn more interest? (By receiving a higher interest rate.)
• How did saving regularly benefit her? (Saving regularly allowed her to have more money in her account on which to earn interest.)

Tell students this lesson will help them determine how to calculate that interest and use it to make more informed financial choices.

Modeling

Continue using the slides to help students recognize the importance of interest rates. Slide 3. Review the terms: interest, compound interest, and simple interest. Be sure students understand the differences and how they are used before proceeding. Slide 4. Explain that interest can be compounded over different lengths of time. How and when it is calculated and added should be included in any agreements or policies related to the account or loan.

Group Activity

Slide 5. Put students into small groups. Tell students the next few slides will demonstrate the difference in simple and compound interest, and they will be working in their groups to solve a series of problems. Allow students some time to calculate answers as needed. Slide 6. Review the scenario posed in the slide, asking how much interest Dianna will earn. Remind students that simple interest is paid only on the principal, making it easier to calculate. Slide 7. Explain the terms in the equation and walk through the steps in calculating simple interest. Slide 8. Have students use the formula to answer how much interest Dianna will earn. ($25.01 interest earned.) Slide 9. Have students use the simple interest formula to solve the two problems. (Problem 1: p=$550; r=.07; t=4; I=$154. Problem 2: p=$870; r=.037; t=2.5; I=$80.48). Slide 10. Review the steps for calculating compound interest. Slide 11. Tell students they will be using the formulae to calculate how much interest Simon will earn in the next two years. Slide 12. Walk students through the equation to calculate Simon’s earned interest. Ask the students how much more interest was earned as a result of compounding than if he earned only simple interest. ($.36). Point out that it doesn’t seem like much for a year or two, but as they saw in the video, over time it adds up. Slide 13. Have students calculate the interest that Jackie will earn in three years ($366.64).

Individual Activity

Slide 14. Tell students that they may also choose to use an online interest calculator to find the answer to these problems. Have students go to the Compound Interest Calculator. Remind them that long-term savings can add up because of compounding interest. Have them use the online calculator to complete two activities noted on the slide. Tell them to write a brief paragraph explaining the difference in results. You may want to select an additional scenario, such as having them enter their current, selecting a monthly amount to save, at a selected interest rate to see how much they would have saved by age 65.

Distribute copies of the Compound Interest Assessment, and have students complete the assignment. Review the answers using the answer key.

Activity 1

Have students work in small groups to research interest rates paid on savings accounts and other savings instruments in their community. Encourage them to use an online calculator to determine the long-term difference in earnings.

Compound Interest Slides

No Frills Money Skills Episode 1

Compound Interest Calculator

Compound Interest Assessment

Compound Interest Assessment Answer Key