An Allowance Strategy for Children

No, I don't actually give my kids hundred dollar bills....

An Allowance Strategy for Children

One of the best things that you can do to help your children out in life is to teach them money management skills. Many problems in life are caused directly or indirectly by money (or lack thereof), so if you can teach them to handle their money sensibly, then you can eliminate many problems before they even arise.

There are many aspects to handling money well, but one of the earliest ways to start is by instituting an allowance. In this blog post, I will discuss the allowance strategy we are using with our children.

Entitled brats

In the adult world, you typically don’t get money handed to you without doing anything. So, even the concept of the allowance is a bit unnatural and one can reasonably argue that by providing an allowance, you’re teaching their child that the world owes them something. Such an entitlement mentality seems like a bad thing–a child with such an attitude is likely to act like a jerk and suffer lots of pain until living in the real world disabuses them of the notion.

Nevertheless, I think an allowance, properly implemented, is unlikely to result in this entitlement mentality. First, a reasonable sized allowance will only be enough to buy a small fraction of what the child will want to acquire. Thus, they are unlikely to feel entitled to anything when they see their money sharply limiting what they can purchase themselves.

In fact, when I was a teenager, one of my brighter friends didn’t want an allowance. His reasoning was that he would actually be able to get more stuff just by begging his parents, since they wouldn’t be able to fall back on the “buy it yourself with your allowance” argument. This strategy worked out quite well for him (in terms of accumulating more stuff, anyway….)

So, I think the entitlement argument mostly a red-herring, unless you give your child enough money to buy whatever they want or don’t force them to live within their budget (i.e. give them an allowance, but still buy them whatever they want when they run out of money). Thus, allowances might not be representative of the real world, but in moderation, they shouldn’t be too destructive either.

The goals

So entitlement isn’t a problem, but neither is it a good reason to provide an allowance. So, before implementing an allowance, it’s important to think about why you would do so. For me, the answer lies in providing a basic education about money. There are several things I want my children to learn.

How to handle money: In this category is the physical act of purchasing goods. They will understand how to go to the cash register at the toy store, hear the cashier tell them how much they own, take the money out of their pocket and give it to the cashier, and get change in return. They’ll learn about sales tax. They’ll learn basic money math (if I buy a Barbie for $12.99, and I have $20, I will get back about $6 in change after tax.) When they get a bit older, they’ll even learn about tipping.

The value of money: If children get whatever they want just by asking their parents, there’s no reason not to ask for anything they want. But if they have an allowance, they have to start making value decisions. Do they want to purchase that video game or a new set of Magic cards? There isn’t enough money to buy both, so they have to decide which one is worth more to them.

Just as importantly, they’ll go through purchase regret, where they buy something shiny, and realize within an hour that it was a really stupid purchase. There will be much wailing and gnashing of teeth, but the child will learn to think carefully before spending their precious money. These are great lessons to learn as a child when the purchase is a $60 bicycle for a doll, rather than as an adult when the purchase is a $300,000 Ferrari.

The power of savings: Just as important as learning the value of spending money is learning the value of savings. It’s important to learn that money spent today cannot be spent tomorrow. They’ll realize that if they hadn’t bought that video game last month, they would have been able to purchase a video game system this month.

The value in giving back: A risk of this focus on money is fostering an obsession with money. Ideally, we don’t want our children to turn into Scrooge. Thus, an allowance also offers an opportunity to teach the value of charity, allowing the child to experience giving away a portion of their own money to a cause they care about.

Advanced financial lessons: Finally, an allowance will enable more advanced financial lessons ranging from the power of compounding, the wealth-draining properties of consumer debt, and the value in investing. If the children don’t have any assets of their own to manage, it’s all theory. Once they are seeing their own assets grow, these lessons become far more real and compelling.

The implementation

In order to try to bootstrap some of these lessons, rather than just throwing money at our kids to spend as they will, we are adopting a three bucket approach. Their standard allowance–which increases at an approximately 10% rate each year–is allocated into three categories.

The first category, making up 60% of the money, goes into the spending category. It can be spent on anything–candy, comics, video games, dolls, books, whatever. The second category, comprising a 30% weighting, goes into savings. This money can still be spent, but only on bigger ticket items that actually require saving up to purchase. Or, it can simply be saved in perpetuity. The final category, at 10%, is for charity.

The hope with this sort of a breakdown is that the children will learn that items that seem prohibitively expensive are actually reachable in reasonable amounts of time simply by saving, while still allowing the children to make impulse purchases if they choose to do so. Ideally, they will also realize that taking care of others is a good thing, and that it’s reasonable to allocate a certain percentage of your budget to giving to others.

Has it worked?

We’ve been offering the allowance for several years. It’s a bit early to know if the lessons the children learn from this will permanently stick, but the basic handling of money seems to be there already. I’ve also seen my eldest decide not to buy something because they thought they’d rather save their money for something better that might come up in the future. So, there are some positive signs that lessons are being learned, but we’re still very early.

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