How to Grow Your Own Money Tree

By Paul H. O'Neill and Sheila Bair • Illustrated by Mark Corcoran

Did you know that money can grow?

I don’t mean that if you plant a dollar bill and water it for a few weeks, a money tree will grow out of the ground. (Though that would be nice, wouldn’t it?)
I mean that money can grow if you “plant” it in the right places—places like savings accounts at banks. If you leave your money in one of these places for a long time, it can grow into a much larger amount.

The reason for this is something called compound interest.

Let’s say that when you were born, your grandparents put $1,000 into a bank account to save for your college education. When they put the money in the bank, the bank agreed to pay 10 percent each year for every year they left the money there. (Ten percent is actually higher than what most banks would pay these days, but it makes the math easier if we use that figure.) This 10 percent is called “interest.” The bank could pay the interest in two ways, one called “simple” and the other called “compound.” Let’s start with simple interest because it is simpler!

Now, let’s say the bank offered to pay compound interest instead of simple interest. Simple interest is based, year after year, on the same amount—$1,000 in our example. Compound interest is different. Year after year, it is based on a bigger and bigger amount.

Here’s how the bank would figure compound interest on your grandparents’ account. In the first year, the bank would pay $100, or 10 percent on the original $1,000, the same as if it were paying simple interest.

At the end of the second year, the bank would combine, or “compound,” the first year’s interest of $100 with the original $1,000. As a result, they would figure the interest based on 10 percent of $1,100, not $1,000. The bank would add the $110 to the $1,100 already in the account for a total of $1,210 after the second year. The bank would do this year after year, figuring each year’s 10 percent interest payment not on the original $1,000, but on $1,000 plus all of the previous years’ interest payments. If the bank kept doing this for 18 years, your grandparents would have about $5,560—more than five times what they started with!

When you are saving money, compound interest can make your money grow into a really big amount. The longer you leave your money in savings, the bigger it will grow. If you wait long enough, the money you “plant” will grow into a great big money tree.

Paul H. O’Neill is a former U.S. Secretary of the Treasury.

Here is another interesting fact about compound interest: the more often your interest is compounded, the faster your money will grow. Imagine that you struck a bargain with your parents. They could reduce your allowance to ten cents a week, but in return, they would agree to pay you an additional 10 percent compound interest each week. They might think that was a good deal. During the first several weeks, your allowance would grow by just a few pennies. Then the magic of compounding interest would start to appear. After a year, your allowance would grow to $14.20 per week. After two years, it would grow to $2,017.61 a week. After eight years, your weekly allowance would be more than sixteen quintillion dollars—many times more dollars than exist in the entire world! (My guess is that your parents would want to change their bargain with you long before that time.)