One of my best friends -- a mother of two young children -- recently asked me for advice about allowance. She liked the idea of giving her older child (age 7) an allowance to start teaching him about money, but she wondered if he was the right age and if it would be inappropriate to give him allowance and not her four-year-old. She was also struggling to determine how much money the allowance should be and how to set rules about earning and spending it.
She is asking all the right questions. Allowances have been a long-debated topic among parents, educators, psychologists and financial literacy experts for years -- and whether parents should provide an allowance, when, how much and what a child is allowed to do with the funds are all important considerations. But another question has emerged: how can parents really be sure that an allowance is helping their child develop good financial habits?
Conventional wisdom has long been that providing kids with money of their own at an early age offers an opportunity for them to start learning about finances -- but some experts are beginning to challenge that notion. Lewis Mandell, professor emeritus of finance and managerial economics at SUNY Buffalo and a pioneer in the field of financial literacy, suggests that allowances -- when given unconditionally -- may not actually lead to increased financial responsibility later in life. However, Mandell does conclude that allowance systems can be effective if they are accompanied by discussions about finances and financial decision making. In short, if you're going to give your kids cash, consider the conversations and rules that should accompany it.
If you already provide an allowance, you're in good company. Well over half (61 percent) of American parents pay allowance to their kids, according to a survey conducted by AICPA, and 54 percent of those say they started when their child was around age 8. Most allowance-paying parents also require their children to earn their allowance; 89 percent say they expect their children to conduct at least some chores to earn allowance money.
So if you're ready to provide an allowance, here are five tips to help make it count toward teaching your children good financial habits:
1. Be clear about the terms. When you're ready to pay allowance, be businesslike about it with your children -- even if they're young. Discuss with them about why they are receiving allowance, whether or not they need to earn it, how much they'll get, how often, and under what circumstances it might be withdrawn or revoked. If you decide to require that certain chores must be done before allowance is paid, be clear about your expectations and stick to them. Being ambiguous or using money as a form of reward and punishment without explanation can be confusing for your children, so be as clear as possible.
2. Consider each child's readiness. Regardless of what age your child is when you decide to pay allowance, it's important to gauge if he or she is receptive to learning about or handling money. If your child has little interest in cash, you may be better off handling requests for toys or outings on an ad hoc basis. If you start an allowance that is tied to chores or grades and your child balks or is unmotivated by the money, you may choose to wait until he or she is older. If, like my friend, you have children of different ages, it isn't necessary to provide them both with an allowance, or the same amount or terms. These things should depend on your goals for the allowance and the level of maturity and development of each child.
3. Set goals. According to the AICPA study, only 1 percent of parents say their kids save any of their allowance. If you want your kids to develop sound money habits in the future, helping them establish some financial goals and determining how the money is spent or saved can be invaluable. Taking your child to an actual bank to set up a savings account can be a powerful lesson about the importance of saving, even before they are ready to grasp the concept of interest. One set of parents I know used allowance as teaching tool by giving their children a set amount of cash with the instruction that they can spend one-third on whatever they like, save one-third for long-term goals, and give the remaining one-third to a worthy cause.
4. Discuss money. As Mandell's study concluded, simply forking over cash is unlikely to instill good financial decision-making down the road. Make financial discussions a part of your day-to-day life in ways that are relevant to your child. For example, during grocery shopping or at the toy store, you can compare prices and ask for their opinions. At the dinner table you could discuss expenses associated family vacations or outings. Talking about why and how you spend, save or give makes money more real for children.
5. Set a consistent example. If you give your child an allowance that is tied to chores and guided by goals, make sure that you are also being a good financial role model. Kids typically know when you're lecturing and when you're actually walking the walk. Talking about making responsible decisions with money will be most powerful when you are actually demonstrating that responsibility.