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When savings don't compound, parents may need to intervene

John David Kromkowski learned about compound interest as a youngster with the help of a passbook savings account at the bank.

"Every time you went in, they would calculate the interest for you and put it in the book," the 49-year-old Baltimore County lawyer recalls. "It made me feel like, 'I'm making money here.' "

Now, Kromkowski wants his son to learn about the miracle of compounding -- earning interest on interest. The problem: Savings accounts pay so little interest now that compounding is negligible.

Kromkowski's son, Simon, deposited $500 a few months ago that he inherited into a savings account with Bank of America that pays an annual rate of 0.04 percent. The first month's interest: one penny.

According to urban legend, Albert Einstein declared compound interest the greatest invention in history, but Simon so far isn't impressed.

"I think it's kind of stupid. You put lot of money in it, but you don't get anything," the 11-year-old said. "I can't buy anything with one cent."

This doesn't mean parents should give up on a lesson about compound interest or not bother to open a savings account for a child.

Compound interest is an important concept, and the earlier it's learned, the better. Money you put away in savings earns interest that is added to the principal. Then you earn interest on that, causing savings to build faster.

Compound interest, though, works against you when you borrow. Interest accrues on the debt over time, and you can end up owing much more than you borrowed.

Savings accounts also remain a valuable teaching tool, despite today's dismal interest rates. Children with bank accounts can learn to become disciplined savers by watching their balance grow with each deposit. Indeed, some of today's top financial minds learned money basics through a childhood account.

Financial experts suggest parents explain to kids that these are highly unusual times of very low rates. And banks and credit unions that visit schools to teach about finances point out that some interest is better than none at all.

Here are a few tips for parents wanting to teach the value of compound interest:

Shop around: You're not going to find a financial institution paying a generous interest rate, but you can find places that offer more than 0.04 percent.

Parents as bankers: The experience of seeing a savings account grow with interest has a powerful impact on children, said Lew Mandell, former dean of the University at Buffalo School of Management and a financial economist with an expertise in children's financial literacy. But if banks won't provide that experience, parents can do so themselves, he said.

Mandell suggests that parents pay the interest, depositing the money quarterly in the child's savings account. It doesn't have to cost much, he said. At 3 percent annual rate, parents would pay out a little more than $15 the first year on a $500 initial deposit.

"To make it more interesting, think of giving the child 5 percent a year," he said. At that rate, parents would pay about $25.50 the first year. After 10 years, the child's account would grow to $821.81.

When higher interest rates return, Mandell said, parents can stop playing banker.

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