Teaching kids to save is hard when saving doesn’t pay.
For most of my adolescence, interest rates were near zero. In fact, even certificates of deposit (CDs), which boast higher interest rates than typical savings accounts, were generating returns below 1%. This was an anomaly. For most of recent history (especially the end of the 20th century), interest rates were much higher.
Investors in the 1960s could reasonably expect at least 5% annual returns from their banks. From the mid-’70s to the mid-’80s, many savers were getting a 10% return. But for those of us who came along after that, such rewards for saving have been impossible.
This was no market accident. When the real estate market collapsed in 2008–09, the US Federal Reserve (the institution responsible for determining US monetary policy) made a series of policy decisions intended to lower the interest rate. Although the Federal Reserve does not directly determine the interest rates, it has a variety of tools to push interest rates up or down.
The leadership of the Federal Reserve saw low interest rates as desirable because lower interest rates mean that it is less costly to borrow money. If businesses want to begin long building projects, for example, lower interest rates would make the projects more financially feasible—all else held constant.
Whether using monetary policy to drive down interest rates is a good idea is its own question. The fact of the matter remains: the Federal Reserve kept interest rates down near zero for a decade. Now that they’ve risen, there is a good opportunity to teach the next generation an important lesson about saving.
One of the major downsides of the decision to keep interest rates near zero is that a generation of Americans never got a chance to learn about the value of savings.
Saving is an integral part of human development. In order to take on big projects, someone must be saving. For example, when you start a business, it often can take months or years before your business makes a profit. How can you pay for workers or materials if you aren’t making a profit? Well, you have to draw from your own savings or someone else’s (the latter would be a loan).
This same logic underlies the decision to go to college. College costs money, and the benefits come later. How can you pay for something that doesn’t deliver a return until much later? Again, you have to leverage savings. Students either have a college fund or they borrow (from the savings of others).
Saving is necessary for the development of a modern economy.
When interest rates are normal, the value of savings is easy to teach because it literally pays to save. If you put $1,000 in a savings account when interest rates are 4% (annual), you end up earning $40 over a year.
This might not sound like a lot, but it can be a great teaching tool for kids for two reasons. First, it’s hard to earn any money as a kid, so any opportunity to earn feels like a big opportunity. Second, the miracle of compound interest can start to produce some truly tangible rewards.
Interest builds on itself, so a $40 gain this year doesn’t mean a $40 gain next year. The interest you earn each year also accumulates interest. This can be hard to visualize without a spreadsheet. To overcome this, the Rule of 72 can help you understand how important interest compounding is.
I’ve discussed this rule writing for FEE before in the context of inflation. The main idea is straightforward. If you divide the number 72 by the annual interest rate, that tells you how many years it will take for your money to double.
For example, let’s say you have $1,000 in your bank account, and the annual interest rate is 6%. Divide 72 by 6, the answer is 12. In 12 years, your balance will grow from $1,000 to $2,000.
Now we can see the importance of our changed interest rates. If savings account interest rates are 0.1% (as they were most of my adolescence), it would take 720 years for your bank account balance to double. Today with interest rates closer to 4%, it would still take about 18 years for an account balance to double. This number, 18, will have clear significance for any parent. This is the perfect amount of time to show your kids the benefit of savings.
