A Yearly Allowance: Teaching Financial Literacy to your Teenager
When I was 14, my parents gave me my entire allowance for the year in January. It seemed like a huge amount of money and I felt fabulously “rich”. But by December, with Christmas looming, I didn’t have much left. Having made no individually extravagant purchases, it was a good lesson in how all the small costs add up to a big total.
Now, I will back up. My parents didn’t just hand over some cash and say “have at it”. First we discussed what expenses I would be responsible for, estimated the costs, and made up an account ledger for me to record each expense so we could review it together at the end of the year. I learned a lot that first year and yet the stakes were low in real life terms. If I’d spent it all in the first month, it’s not like rent or food was on the line.
Now that I have children of my own and have thought about how to teach them about dealing with money wisely, I’m even more convinced that this idea is brilliant.
Shouldn’t kids EARN their money?
One criticism I have heard when discussing this idea is that you are handing a kid money without them “earning” it. An allowance is not a gift of money, but is giving a child the necessary tools to learn an important life skill. Just as signing them up for swimming lessons or providing sports gear or a musical instrument is not free, neither is teaching them financial literacy. But to achieve this goal, the money needs to be accompanied with discussions about budgeting, saving, debt, and investing.
Some families pay allowance based on completion of certain tasks or goals (e.g. household chores or certain achievements at school or practicing a sport or instrument). My opinion is that household chores are expected as a contribution to maintaining the home we all share. Likewise, I believe learning should be intrinsically motivated as much as possible.
But what about making them earn the money by babysitting or some other job open to kids? That is certainly a valuable experience but earning money is a distinct skill from managing money. The two skills are intertwined, but for young people, it’s probably easier to teach them separately as earned income is likely to be quite minimal. I consider earned money to be discretionary and allowance to be a teaching tool.
So how does it work?
Assuming that your child has had some experience with spending their own money, start by discussing what they spend it on (if they can remember) and asking them to suggest categories of spending they could be responsible for with a yearly allowance. This is a good time to shift the responsibility for purchasing some items that you would already be paying for such as clothing or costs associated with any extra-curricular activities.
Next, write up a budget together, estimating costs in each category, and leaving some room for spending on fun items or activities. It’s important to be realistic so that they have some chance of staying within the budget, but don’t be too generous either or the planning and budgeting skills will not be developed. If you’re concerned about their readiness, you can ask them to track current spending for a month or two before you plan to start the yearly allowance. That expense tracking will be an important part of the process, so they will need to cultivate the habit. You can use a paper account ledger and an envelope for saving receipts, like I did back in the 90s, or you can use a spreadsheet or budgeting app. Whatever approach, they must be accountable for how the money is spent so that they can review it and learn from it.
You must be comfortable with them potentially failing. Don’t include any items that will cause you to need to “rescue” them. It needs to be ok for them to be uncomfortable or run out of money because that will make a big impact if it happens. If you want to give them a bit more of a safety net, start with a half-yearly allowance or do a check-in after 6 months. You can always expand the scope of their budget as you both gain confidence in their financial choices.
At the end of the year, you should spend some time reviewing the experience together. Find out where they struggled and where they did well, look at spending patterns, discuss strategies for improving habits, and help them plan goals and a budget for the next year.
The point of the yearly allowance as a teaching tool is that it gives them the experience of having what sounds like a lot of money but also having a lot of expenses for which they are responsible. Many people never encounter this situation until they are living on their own, earning an income or borrowing with student loans (which is suddenly much more money than they’ve ever managed) and the stakes are a lot higher (e.g. rent, food, tuition, transportation). Credit card debt is easily accrued when inexperienced young adults spend beyond their means. Much better to totally mess up managing your money when consequences like eviction and debt aren’t part of the equation.
What if we can’t afford a yearly allowance?
If your family budget won’t allow for any extra discretionary spending or you can’t provide a yearly amount in advance, instead you can give them a hand in some of the actual household expenses. This type of practical experience is engaging for kids at any age and probably a good activity regardless of your financial situation. Start with giving them a day’s budget for the family dinner, a list of what they are allowed to use in the pantry, and go shopping with them. Expand it to a week’s budget as they gain experience. If your finances are tight, giving them room to fail might need to look different (e.g. everyone eats beans on toast for a week). The opportunity to be involved in managing money in a responsible manner and be the decision-maker is what counts.
What will they learn?
Aside from the specific financial literacy skills you discuss during the planning and review phases, a yearly allowance will help them develop associated skills like delaying gratification, buying secondhand or bartering, resisting peer pressure spending or lending, learning the trade-offs between cost and quality, and researching and comparing prices. Whatever your approach, the key is that they have enough involvement in managing some money and financial responsibilities that they can learn (possibly by falling short at first) to avoid the bigger mistakes that come with spending beyond your means, not knowing where your money is going, and not understanding basic financial principles.