Capping Your Liability: The Allowance as a Training Tool

Kids are expensive. I fully understood that at a conceptual level before I signed on, but I’m always amazed at the new and interesting ways the cost manifests itself. Diapers and formula provided the first kick in the nuts, and they’ve been followed by an unending expense stream of the large (daycare, college saving), the small (I wish Lego was a public company I could own), and the interesting (I thought we just did a belt test, sensei?).

Yes, my two little goblins will cost me a pretty penny for 20 some odd years, and I’m just fine with that. In terms of what brings me happiness and hope, they’re the greatest assets I have.

 

$250K? That’s Chumpchange

But there is another area of financial exposure that could be far greater than the cost to raise, or the cost of college: the money habits I give my children. When you consider all of the earnings your child will have and the power of compound interest, there could be a gulf of millions of dollars in the financial fortunes of a smart saver and an undisciplined spendthrift.

And that’s just the financial measurement. Excellent financial discipline could be a key to them having a fulfilling life, while poor money habits could give them a wretched one and turn them into permanent drains on my own finances, with the real fun beginning after college.*

And finally, if you not only teach your children excellent money habits, but also teach them how to pass on the same, you could be giving a priceless legacy to your descendants for centuries.

So, with the financial fate of all future generations of my clan in my hands, earlier this summer I tackled the momentous decision: what to do for my 7 year-old’s allowance.

My Mission

He’s just started to embrace the concept of money and was about to turn 7, and I felt this was the perfect time to take the plunge. Since I knew that I’d be anchored on whatever model I selected, I wanted to be thoughtful in my approach. My modest goals for starting an allowance were:

• Teach the art of saving money
• Teach financial discipline and money management
• Teach deferred gratification and financial tradeoffs
• Establish the link between work and money
• NOT provide perverse incentives to any other area of his development

I didn’t want to blindly mirror the model I’d grown up with – I knew there were aspects I could improve, and I was curious what was working best for others.

But talking to fellow parents was inconclusive: some did nothing yet, while others were taking casual first steps. No one seemed overly confident or concerned if they had the right model (they somehow missed the fact that the financial fates of all their future descendants rested on getting this right). The internet provided a smorgasbord of information (surprise!), but no solid case for a best model.

The Models

So I set pen to paper, and tried to define my own universe of allowance options:

• No allowance / get a job
• Pay allowance – no strings attached
• Pay allowance for a wider role / increased responsibilities
• Pay for specific chores
• Pay for academic performance or activities

and assess the pros & cons of each against my goals.

No Allowance / Get a Job

I’ll definitely move to this one someday as it is the best preparation for the real world, but for a 7 year old, it seems a bit ambitious. Teaching him saving and money management is more important to me right now, even if the stream of money that allows it is less “real”.

Last year, we did trifle with the beginnings of a paracord bracelet manufacturing enterprise, but labor unrest sank the business plan when I realized I’d be doing most of the work for free.

Pay Allowance – No Strings Attached

Having a steady stream of income is a great learning tool and can help with many of my objectives, and this model does have simplicity on its side.

However, paying with no strings attached seems to miss the opportunity for extra learning, making this one of the weakest options.

Pay Allowance for a Wider Role / Increased Responsibilities

This has the same advantages as the one above, but it also requires a package of chores and other activities to earn the allowance. I like this because it raises the concept above an individual chore: you’re a contributing member of the family and you will receive a wage of sorts for your contributions.

Some knock this model with the argument that kids should be helping out the family anyway with a base load of chores. There’s also a risk that the link between specific work and the allowance blurs because of the “package” nature of the chores.

Pay for Specific Chores

Paying a la carte for chores seems quite popular, and it is likely the best option for a young child to establish the work = money relationship. The more you work, the more you earn, and it gives a child a great opportunity to show initiative. If you have more than one child, it can also turn into an excellent experiment (and competition), where you can compare habits across them.

Some parents marry this model with a requirement that certain chores are part of the deal and done for free.

But I’m concerned that this model, with enough chores to make it meaningful, could turn into a massive management exercise. Chores and prices would need to be kept updated, and mismatches between effort required and price would consistently creep in. I’m also worried about my son turning into a mercenary who will groan at having to do anything for “free”. From a microeconomics standpoint, this one could be a bit messy.

But my chief concern is from some of the anecdotes I hear. Some kids on this model will simply turn on the Rocky music and do every possible chore – and beg for more – when they suddenly need money. The ability to bump up earnings at a moment’s notice (basically viewing the pool of chores as your bank) is contrary to my goal of teaching saving as a top priority.

In any event, I’ll be using this model down the road for bigger jobs (e.g., mowing the lawn), but it’ll probably be part of a tailored solution.

Pay for Academic Performance or Activities

This model involves paying for grades (whether by grading period or individual test), paying for reading books, etc. This one seems to work well for many, and it is clearly rewarding desired behavior.

But I have a lot of trouble paying for specific academic performance. I don’t want to be standing by with a bigger and bigger bag of carrots throughout my son’s academic career. What would happen if / when I stopped? What happens once he’s in the real world, without the extra incentives?

We’re taking the attitude that our boys had better do well in school because that is simply what one does. Right now the praise of mom and dad has been enough – to a 7 year old that is worth far more than money – and we’re trying to build the drive that makes excellent academic performance feed itself. Fingers crossed it keeps working.

Books, for me, are their own reward. Reading books is one of life’s greatest pleasures, and I’d never want to associate it with “work”, or something that needs an added incentive. You would have had to pay me not to read books when I was a kid, so this is definitely off our list.

Which Model is Best?

I’ve found no one who can make an overwhelming case for the “right” model, and I’m sure a legion of people can find fatal flaws with each one of them.

However, I think the risk with each allowance model rests in its execution. Adding money to the mix of family responsibilities, chores, and academics will always bring complexity that needs to be managed, and the law of unintended consequences is guaranteed to rear its head.

Staying focused on the goals you’ve set and being aware of the risks and drawbacks of your model of choice are the keys. You can react and finesse an allowance at the first hint it’s not working far easier than you can cure an entrenched bad money habit that may have snuck in.

 

In my next post, we’ll discuss the model we chose, how we executed it, and how it’s working.

 

 

* You could argue that once my lads are out of the nest, their financial fortunes – and their potential to be the greatest financial liabilities I’ve ever had – is no longer my problem. That is true, but right now I’m not distinguishing between their finances and my own, since the legacy I leave them is one of the assets I’m trying to maximize. My main hope is to never face the tough decision of either watching my children writhe in financial pain or having to bail them out at enormous expense. The pressure is on to get this right!