How An Allowance Helps Kids Get Money-Smart

By Andrew Beattie AAA

The vast majority of children are destined for a financial future that differs little from that of their parents. In many cases, the middle class raise the next generation of middle class people, the poor raise the poor and the wealthy raise the wealthy. Very few children move up the ladder from their parents, while sliding down is as simple as swiping a credit card.

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If there is going to be a change between your level of wealth and that of your children, the odds are that they will do worse financially, rather than better. They may earn more than you do, but they will also spend more and save less. In recent years, the practices of saving to buy and general frugality have been sabotaged by quick credit, payment plans and a "why wait?" shopping attitude. Read on to learn how granting your children an allowance can help you to point them toward financial success. (To read more about income classes, see Losing The Middle Class and Capital Gains Tax Cuts For Middle Income Investors.)

Deadly Silence
Many parents avoid discussing money with their children, but, unfortunately, even omitting this subject can have an effect on the financial lessons they pick up and the attitudes they adopt. In general, parents tend to avoid speaking to their children about finances because it is an "adult" subject. Finance is seen as something that a child can worry about when childhood gives way to adulthood and, as a result, parents neglect to address these topics with their children at an early age. Implicit in this silence, however, are a number of negative signals - if you do not discuss finances with your child, it may suggest to him or her that money is either unimportant or something to fear. (To see more articles on money and kids, see Teach Your Child About Investing, Teaching Your Child To Be Financially Savvy and Close The Bank Of Mom And Dad.)

For many children, this silence continues at their schools, with only the most cursory glances at accounting and vital life skills like budgeting. The undeniable truth is that your children are going to learn about finances from you. But to do this effectively, you need to develop a plan and some techniques that will help make the lessons count. A good first step is granting your children an allowance. (Find out some easy budget steps in The Generation Gap, The Beauty Of Budgeting, Savings Plans For Minors and The Indiana Jones Guide To Getting Ahead.)

Starting an Allowance
It is hard to know when your child is ready for an allowance. If you start before the diapers are off, your children won't understand the significance of the money they receive. Although it is not a hard and fast rule, an appropriate starting point is when your child's verbal comprehension is high enough for you explain how the allowance will work. When your child reaches this level, there are three types of allowance to choose from: the gift system, the reward system and the income system.

The Gift System
The gift system is a regular payment to your child that is not dependent on any chores that your child does or does not do. Simply put, you give your child a monetary gift just for being your child. The advantages of this system are that it is regular and unchanging. You will not be raising or lowering the amount of the allowance because of your child's behavior. However, the disadvantages are numerous. Your child will not get a sense of achievement from the allowance, nor will he or she truly appreciate it. Additionally, it is harder to instill a sense of fiscal responsibility when your child receives the money without showing any initiative or desire.

The Reward System
The reward system is the most common system parents choose. In this system, parents set chores for their children to perform on a weekly or monthly basis and then pay a set amount for the successful completion of the chores. Chores typically include tasks like washing dishes and making the bed. The advantages of this system are that there are consequences for not doing the assigned chores and a reward for doing them. In other words, this system provides a mix of positive reinforcement and punishment. The disadvantages are somewhat difficult to see when your child is young, but the reward system is also guilty of reducing your expectations for your child to a monetary figure. Your child should clean his or her room and help with the dishes regardless of any allowance. If you use the reward system, you will encourage your children's desire for money at the cost of their sense of responsibility.

The Income System
The third system, the income system, works much like real life. When there is a job to do that is not expected of your child - for example, washing the car or weeding the garden - you can pay him or her to do it. Basically, you want to establish an allowance that is paid to your child for work outside of regular responsibilities. This allowance will be variable and irregular, but it will do far more for your child's financial future than the other two.

In practice, you will have to agree on how much a particular job is worth. Write down all the jobs and the agreed upon payment for each one on a large sheet of paper. Allow your child to check them off as they are completed. Then, you can use this work schedule to add up your child's allowance together. If your child does not keep up with regular responsibilities, he or she will have less time to do paying jobs. You can also withhold the work schedule if your child has not completed his or her regular duties.

Teach Yourself First
The deciding factor in whether or not a child will succeed financially is how much financial education they receive and when they receive it. One factor that limits how much your child can learn is the amount of knowledge you are able to give them. Providing your child with an allowance is great way to get the ball rolling, but as a parent, you should also share your own real-life lessons in budgeting, frugality and the importance of emergency funds. (To read more, see Build Yourself An Emergency Fund.)

To give your child the best advantage, you will need a working knowledge about investing. Developing this can be as simple as going to the public library or searching the internet. There are numerous books on portfolios and stocks, and the internet is a cornucopia of useful links and frequently asked questions. (View some of Investopedia's FAQs here.)

Many books and websites are written in plain language and include easy-to-follow examples. You do not need to master concepts like futures trading, but you will need to know the advantages of an index fund over a mutual fund and how both of those compare to bonds. The best way to educate your child is to educate yourself first. If you are lost in the financial quagmire, you owe it to your child to chart a course out. (Read more about index and mutual funds in Index Investing, The Lowdown On Index Funds and Mutual Fund Basics.)

If you share your experiences with your child, he or she will be able to learn from your mistakes. Furthermore, all of your research might even pay off for you, as you'll have a better financial plan for yourself, which could provide a great lesson for your children in itself.

Conclusion
For parents who are serious about instilling their children with some financial knowledge, there is more to an allowance than just the transfer of a trivial amount of cash. The system you choose has an impact on both your child's financial outlook and his or her character. Pairing this system up with discussions about money and finance and your own financial experiences is also invaluable. If you want to pave the way for success in your children's financial future, you can't just hope for the best. Instead, provide them with the skills that will make this success possible.

To find out more on how to help your kids budget, see Opening Your Child's First Bank Account and What Are You Teaching Your Kids About Money?

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