What is interest?

Today, we're going to talk about a super-important concept when you start managing your money: interest.

You may have heard this word in adult conversations or in connection with a bank account, but what exactly does it mean? Why do some people say their money "works" for them? Can this work for you too?

We'll explain it all, simply and with concrete examples, so you can understand how to make your money grow and why it pays to save.

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What is interest?

Interest is money you earn or have to pay.

If you put your money in a bank, the bank may give you interest as a reward for keeping your money there.

If you borrow money (for example, if your parents take out a loan to buy a house or a car), they have to pay interest to the bank in addition to repaying the amount borrowed.

It's as if money were a seed that you planted: if you let it grow, it can produce a tree with lots of fruit. The longer you wait, the more fruit there is!

But there are different types of interest: simple interest, compound interest and smoothed interest. Let's see what they mean.

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Simple interest: a basic calculation

Simple interest is the easiest to understand. Interest is calculated only on the initial sum (called the initial capital).

Example:

You put €100 into a savings account with an annual interest rate of 5%.

At the end of the first year, the bank adds €5 (100 × 5% = €5).

The following year, you earn another €5, and so on every year.

Result: At the end of 5 years, you'll have €125 (initial €100 + €5 × 5 years).

Simple interest does not change; it is always calculated on the initial sum.

Imagine you lend a friend 10 marbles and he gives you back 11 marbles after a week. The extra marble is simple interest. If you start again each week, you always earn 1 marble.

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Compound interest: the snowball effect

Compound interest, on the other hand, is much more interesting, because instead of being calculated only on the starting sum, it is also calculated on the interest already earned.

Example:

You put €100 into an account with 5% annual compound interest.

After 1 year, you have €105 (as with simple interest).

But in the second year, the 5% is calculated not on €100, but on €105. So you earn €5.25 instead of €5.

The following year, the bank calculates 5% on €110.25, and so on...

Result: At the end of 5 years, instead of €125 as with simple interest, you'll have around €127.63.

Why is that interesting? Because the longer you wait, the bigger the difference! The snowball effect means that your money grows faster and faster.

Imagine that every time you win an extra marble, you don't spend it and lend it to your friend. He then gives you more marbles back, and so on. Your stock grows faster and faster!‍

Why is it so powerful?

If we compare over 20 years with a rate of 5%:

With simple interest, you get €200.

With compound interest, you get €265.

Imagine over 30 or 40 years! That's why adults say you should start saving young: the earlier you start, the more compound interest you'll earn, and the more your money will grow.

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Smoothed interest: balanced repayment

Smoothed interest is a method used mainly for loans, for example when your parents buy a house.

Instead of paying a lot of interest at the beginning and little at the end, the bank spreads the payments evenly over the life of the loan.

Example:

Your parents have to repay €12,000 over 3 years.

If they paid no smoothed interest, they would pay €5,000 in the first year, €4,000 in the second and €3,000 in the third.

With smoothed interest, they repay €4,000 each year, which is easier on the budget.

It's as if you had to give €10 to a friend and instead of giving them €6 and then €4, you gave them €5 each time. It helps you organize your spending better.

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How do you explain this to children?

Here's a simple tip for explaining interest to children:

Simple interest:
If you're given a balloon every year, you'll always have one more every year.

Compound interest:
If we give you a balloon the first year, then a balloon + 5% of balloons the following year, you'll end up with a lot more balloons!

Smoothed interest:
If you have to give your friend 10 balls, rather than giving him 6 balls at once and then 4 later, you give him 5 balls each time to balance things out.

Why is it important to save now?

At Bloon, we believe that understanding these concepts from childhood is essential to managing money well in later life.

By setting aside a little money regularly, you can benefit from the effect of compound interest and watch your savings grow over time.
Learning to manage a budget and understand how loans work is important to avoid unpleasant surprises later on.
With Bloon, children can track their savings, watch interest grow and learn to manage their money in complete security, with the support of their parents.