Guest Post: Raising Financially Responsible Kids

Hi everyone! We sincerely hope that you've had a very Merry Christmas with your families. This week at Parenting on Pennies, we have a guest post from Joseph Sheeley. He is providing tips for raising financially responsible kids. Thank you, Joseph for such a great post! 

P.S. Next week will be the obligatory "setting new goals for a new year" post. Stay tuned!

By Joseph Sheeley (a.k.a. SmallIvy)

Good money habits are critical for future economic success.  You could hand someone with bad habits $100,000 and it would be gone in a matter of months.  You could turn someone with good money habits loose with $1000 for rent for a few months and they'd never need any help ever again.  Unfortunately, many children never learn to handle money well.  Perhaps this is because finances are a taboo topics in a family, right up there with where their siblings came from, so many young adults enter the world with very little understanding of how to handle money. 

But teaching basic finance skills to your children needs not be difficult.  We started early with our children and as a result they have a better understanding of finances than many adults.  Here are a few tricks that we used to introduce our kids to important money concepts that you can use with your own children:

1.  Dollar Drinks

Any parent knows that kids will tend to automatically order a soft drink when they sit down at a restaurant.  This habit will often carry with them into adulthood where they have a Coke or a glass of wine with every meal.  While there is nothing wrong with the occasional beverage to enhance a meal, soft drinks add $3 per person to the bill at many restaurants and even a beer can run $6 or more. 

Often kids will just take a sip or two of their drink during the meal, making that drink cost about $1 per sip.  Even as adults, you'll often find that if the food comes reasonably quickly, you'll barely touch your non-alcoholic drink.  Because alcoholic drinks cost more, adults will at least tend to finish them, but add a couple of glasses of wine or mixed-drinks and you'll be paying as much for drinks as for your meal.  You'll also be adding 500 to 1000 calories, which most adults really don't need. 

Just making the switch to water will save you a lot of money, plus reduce calories and improve your health.  If you can learn this habit young and carry it with you into adulthood, it will pay off big over your lifetime.  This can be a tough sale for a child who is used to a soft drink or juice at every meal, however. That is until you add a small financial incentive. 

We started giving our children $1 each time they ordered a water instead of a soft drink at a restaurant.  Not only did this save us $1 to $2 per child per meal for kids drinks, but it also taught our children to think about whether a purchase was worth the price before they made it.  When the drink seemed to have no cost, since they were not footing the bill, they would automatically order a drink when they sat down whether they really wanted it or not.  Once the cost of the drink became their money, they started choosing whether or not to spend the money rather than just going on autopilot.

Once they realized that they could have a small toy or something else they wanted instead of having the drink, we found that they really didn't get drinks that often.  Suddenly both children were ordering waters at all of their meals unless they really wanted a soft drink.  Normally we only go out once per week, but my son actually realized when we were on a long vacation where we were eating all of our meals out that he could make $20 or $30 during the course of the trip by getting waters.  In addition to incentivizing him to be judicious in his purchases, this saved us between $20 and $60 during the course of the trip in drink costs, which was enough to cover several kids-meals.  Win-win!

2. Put Them on Commission

Many children have a set of chores that they are expected to do.  They are then either given an allowance to buy the things they want or their parents just buy the things that they want after a suitable period of negotiations.  Many parents think that having their children do chores teaches responsibility and the need to do things for the family, but often it just teaches their children that work is undesirable and to do as little as is needed to meet the bare minimum requirements.  In a job or entrepreneurial environment it is the people who go above and beyond and think of ways to meet the needs of their customers better that do the best. 

Likewise, many parents think that providing their children with an allowance will teach them how to handle money since now they'll be choosing what to spend it on.  But because they receive the same amount of money regardless of how much work they do, rather than linking their income to their output, children learn that they deserve to be paid just because they breathe air.  If no allowance is given and things are just bought when a child asks, they don't learn to assign a value to things at all.  Because they didn't need to put work into acquiring the money to purchase their items, they may not take care of them and may not be careful with their selections.  Money just seems like a limitless thing.

"Our children tend to be highly motivated to do chores."

While we do have tasks that our children are expected to do gratis as a member of the household, we also started providing tasks that our children could do for a commission.  This started when they were very young with a quarter for replacing the bag in the trash cans and grew into larger amounts for larger tasks like $3 to put the dishes in the dishwasher away or even $15 to mow the front lawn. 

Note that we do not underpay our children for the tasks they complete as some parents tend to do since this would be a demotivator and, frankly, unfair.  If we would need to pay a maid $50 to clean the house, we would pay our children $6 to sweep and mop a kitchen floor.  If it would cost us $10 to have our car washed, we pay $10.

This system has created some interesting results.  These are:

* Our children tend to be highly motivated to do chores.  Our son has the nightly task of cleaning out the three cat litter-boxes we have (why we have so many cats is another story).  He does this without being asked and does an excellent job.  At times our kids get on a kick about earning money and will ask us for additional tasks to do, seeing how much they can earn.  They have learned that they can make more by figuring out what needs to be done and doing more, which is exactly the attitude to have when they get out into the workforce. 

* We've had labor strikes.  One issue we do have is that sometimes our children will have made so much money and have nothing they really want to buy.  It is really interesting how similar this is to people in manual labor jobs who tend to work when they need money and then not show up to work when they have enough cash to meet their needs.  While this may satisfy their immediate needs, this is obviously not the way to advance in the workforce or run a successful company.  At these times they may not want to do the tasks, even if we really need to have these tasks done.  At these times we've explained to our children that when you have a job you need to continue to work even when you don't need money right now because otherwise you'll lose that job and you won't have the work available when you do need money.

* We've seen the detrimental effects of unneeded charity.  Early on when our son had just started to do tasks for commission, putting the trash bags in the can for a quarter and earning maybe fifty cents per week, his grandfather gave him $20 for a trip we were taking.  Getting this large sum of money made him not want to keep doing his task for a measly quarter.  Once again we explained to him that he still needed to do his work even if he didn't need the money right now. 

  

3. Bank of MAD

In addition to putting our kids on commission, we also formed the Bank of Mom and Dad, known familiarly as the “Bank of MAD.”  This bank pays an interest rate of 5%, compounded whenever we remember to calculate interest.  (And no, we are not taking any new deposits except from existing customers.)  Each child has a passport book and a checkbook with a few checks.  This is to have them start learning about saving money and how banking works.

One thing that was truly surprising with the Bank of MAD is how much money the kids deposit.  Instead of spending every dollar as it comes to them, they often make deposits, letting it build up until they decide to buy something fairly large.  One item my son purchased when he was about 10 was an iPod, which seemed fine until he decided to walk into the lake with it in his pocket.  It was about then that I decided that the only thing a kid should own that cost more than about $100 was a bicycle or something else equally sturdy.   

"..this is exactly what businesses and banks are doing in the real economy."

Having both the commission system and the Bank of MAD has had some interesting results and actually helped me understand economics a little better.  We keep some cash in a drawer for chores.  At first we would pay our children, then they would come back every so often and make a deposit in the bank, at which point we would put their cash back in the drawer.  Eventually they just started putting their pay into the bank without handling cash at all some of the time.  When they wanted to buy something, we would then typically use our debit card and then deduct the purchase price from their bank accounts.

What was interesting was to see the cash go out to them for pay, and then come right back and be put into the drawer when they made a deposit.  When they did something else, the same bills would come out and be used to pay them again.  This made me realize that is exactly what businesses and banks are doing in the real economy:  When you earn money, you are paid but then some of that money is put back into the bank.  They therefore get to keep making use of the money until you actually spend it somehow.

Of course, sibling rivalry affected the Bank of MAD system.  My son, who is three years older than my daughter, told her when she was about six that the money she was putting into the account was going to him.  He even called the money he was receiving, “Amy money,” in reference to her.  Since she saw the bills that she was depositing going out to him as he did tasks, she assumed it was true.  He had her in tears and we had to explain to her that she still had the money in the account and could retrieve it whenever she wanted and that the actual bills did not matter.  Maybe this was a good lesson for her in how banking worked, or just how devious big brothers can be.

4. MAD Brokerage

Because we wanted our children to learn about investing, in addition to the Bank of MAD, we also have the MAD brokerage.  One issue with trying to have children buy stocks with a traditional brokerage firm “for real” is that they have very little money to invest.  If the minimum brokerage fee is $10 and they're buying one share of stock for $50, they would end up paying about a 20% commission – not good.  In addition, we'd need to keep track of stock certificates since they would have difficulty opening a brokerage account with such a small amount of money.

Using the MAD brokerage, the kids can invest their money and buy any of the stocks we hold in our regular investment accounts.  We just note down in a separate passbook (and in a spreadsheet on the computer) when they bought the shares and how much they paid.  They can then track their investments and see how well they are doing.  In the future they can let us know when they want to sell shares and we can just put the money in their Bank of MAD accounts, or give them cash, as appropriate.  In this way they get the experience of investing without needing to pay brokerage commissions.  We typically use the stock price at the close of trading the day they make the order as the price they pay or receive.  Alternatively, you could allow them to invest in some of the mutual funds you own instead of individual stocks.

Note that we choose to use investments that we already own, both to save them the trouble of picking stocks from the whole market and to protect ourselves in case the stocks they buy do really, really well.  You could allow them to choose any stock in the market, but you run the risk of needing to find some serious cash should they hit a grand slam.  Realize also that you might need to sell some shares to pay them if you do not have enough cash lying around, especially if they cash out all at once when they are going to college or something.  You could also set up a brokerage for them at that point and actually transfer the shares to them.  If you do, whatever price you paid for the shares will go with them, however, so you could be sticking them with a tax burden if the shares were already highly appreciated when they bought them.

Note also that you do need to pay attention to gift tax rules if you start your own MAD brokerage house.  Since they are not actually buying shares of stock, instead just tracking how your shares do and then you are giving them cash when they sell, any gain that they make is a gift that you and your spouse are making to them.  Currently gift taxes are at about $12,500 per person, or $25,000 for a married couple, so this will probably not be an issue.  Be mindful of the limits, however, if you discover that you are parent to the next Warren Buffett and they start talking about company moats and such. 

Joseph Sheeley writes under the pseudonym SmallIvy on The Small Investor, a blog dedicated to personal finance and investing.  A rocket scientist by day, he has been investing since the age of 12 and has portfolios for more than thirty-five years. He is the author of the book, The SmallIvy Book of Investing, Book 1: Investing to Grow Wealthy and FIREd by Fifty, a book on budgeting and cash flow management.