January 24, 2012 in Smart Money

Kids spend, save, learn with an allowance

Parents take note: Bad money habits don’t pay. So if you want your children to have great money skills, consider giving them an allowance.

An allowance teaches kids how to earn, save, invest, budget, delay gratification and make wise purchasing decisions. “(These are) all the skills needed to live a sound financial life as an adult,” says Karyn Hodgens, co-founder of the parenting website Kidnexions and author of “Raised for Richness.”

The key is tailoring the lessons to the child’s age and abilities. Money management experts advise starting early and raising the bar as kids get older to teach the value of earning, saving and giving money to worthy causes.

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“It makes kids money-conscious,” says Laura Levine, executive director of the Jump$tart Coalition for Personal Financial Literacy, a group in Washington, D.C., that teaches money skills to children. “It’s our job as parents to teach good money skills because these skills don’t teach themselves,” she says.

Here’s how to turn an allowance into a lesson.

Early money lessons

Money lessons can begin as early as age 3 or as soon as children express interest in money, Levine says. Even at an early age, a weekly allowance teaches coin recognition and how to complete shopping transactions.

Every trip to the store is a potential lesson. “Give your child a dollar to spend on anything he’d like, such as a snack,” Levine says. “Pretty soon, he’ll understand the value of money and that it has limits.”

Teach basic saving using a see-through jar or piggy bank, Levine says. Draw a line on the bank, and fill it with coins to reach the goal.

How much should you give? For young children, the rule of thumb is a dollar or two a week per year of age, Levine says. Or skip a formal allowance at this stage and teach spending and saving using a few coins given as a reward for extra chores and cash gifts they receive from relatives on holidays.

The first allowance

Regular, weekly allowances should begin in kindergarten, says Neale Godfrey, founder of the Children’s Financial Network, a company in Chester, N.J., that promotes financial literacy in children. At that time, parents should supply four clear containers children can use to hold money for various causes — charity, spending money, saving for bigger purchases and saving for college.

“Pay the allowance in small bills and coins, so the child can divide up the money,” Godfrey says.

She recommends 10 percent of the allowance goes to charity and the other 90 percent allocated to the other categories.

Teach them how to compare prices. And come up with a list of extra jobs they can do when they want to earn more money to reach a goal, Hodgens says. These are age-appropriate jobs that aren’t part of their usual household chores.

Younger children could recycle cans for extra money. Older kids could bag leaves in the fall or wash the family car, Levine says. Older children with more expensive tastes are more likely to tap into extra jobs.

This arrangement encourages hard work and avoids the allowance-tied-to-chores pitfall. “You don’t want kids to expect to be paid for everything,” she says.

In fourth grade, up the ante. “Teach compound interest. Show them what happens if they save their money over time,” says Bill Dwight, founder of FamZoo.com, a virtual allowance tracker. Reinforce the lesson by contributing 10 percent each month to their savings, so they can see compounding work.

Remember: Financial literacy means learning to spend, too. Letting children spend on what they choose, within reason, motivates them, Hodgens says. When they make mistakes or regret a purchase, don’t bail them out.

“Instead, talk to them about what they can do better in the future,” she says.

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The tween years

Middle schoolers have more complex financial needs than younger children. That’s why this age group is ready for bigger lessons in spending, earning and saving.

It’s the time to teach entrepreneurship and encourage children to turn their talents into income, whether it’s baby-sitting or starting their own business. “Thanks to the Internet, there are opportunities for all kinds of microbusinesses that kids could do,” Dwight says.

Ray Martin, a financial planner and contributor to CBS MoneyWatch, says if you haven’t already, it’s time to open a bank account for your kid. Mature tweens may be ready for an ATM card with a no-debit feature. “They can then learn real-life money management, like checking balances online,” he says.

Tweens also are ready to learn basic investing — how the stock market works and how to buy shares, Hodgens says. They can even invest some of their own savings or look over your shoulder when you’re managing your portfolio.

Parents can add special budgets to tweens’ financial universe, such as back-to-school clothing allowances. Discussing what they have, what they need and how much to spend teaches them what is a necessity and a luxury and how to budget, Godfrey says.

“And if your child feels he can’t live without designer jeans, he can spend some of his money to buy them,” she says.

Getting teens ready for the wild

A high schooler’s financial life should become more adult-like. Levine says stop giving a weekly allowance in freshman year and give a lump sum each month or semester to teach budgeting larger sums of money. When they get a job, outline what percentages go to savings and spending before their first check arrives.

Introduce the concept of fixed-versus-discretionary expenses by giving them monthly bills you expect them to pay such as a cellphone bill or car insurance, Hodgens says.

Dwight says to encourage them to invest and to manage money in their own bank accounts, which you can monitor online. When they start their first job, “open a Roth IRA on their behalf, and match a portion of the money they put into it,” Dwight says.

Allowances can be structured in many ways, but the goal is always to teach children the value of money and the skills they’ll need to manage it as adults, he says.

“It teaches children how to live within their means,” Dwight says. “If they learn when they are young, they’re learning in an environment where it’s safer to make mistakes.”