How we handle allowance in our family

tl;dr: be the bank, pay a high interest rate

I’ve had a couple of friends ask me how we handle allowance for our kids, so I thought I’d write it down and share it in case anyone finds it interesting or useful.

We’ve been doing this for a few years, so I’ll deploy some revisionist history and pretend that we had these three goals when we started:

1. Teach them to be responsible with money. God knows we’ve struggled with this; might as help them start somewhere.
2. Teach them the value of saving/investing and the magic of compounding interest.
3. Help them make better choices about how they spend their money.

Here’s how it works…

First, we set the allowance for each kid. Do what feels right for you and what works for your family and your parenting style. I’m not here to tell you the amount or how you come to it — that’s your decision as the parent. I do think that it’s good to give your kids an opportunity to negotiate with you (and renegotiate at periodic intervals), if only to give them some practice having a conversation with an authority figure about money. Who knows; might come in handy some day.

Second, we don’t give them cash. Instead, we deposit their allowance in a “bank account.” This helps avoid the bulging wallet / piggy bank syndrome, where the kid feels a burning need to go out and SPEND SPEND SPEND. This doesn’t mean they can’t have a little walking around money, but it helps keep things simple: you can automate the deposit, and it eliminates any temptation of sibling-on-sibling theft.

This “bank account” is just a spreadsheet, because I’m the bank. When I was a kid I was all excited by my passbook savings account. (I’m old enough to have literally had an actual passbook.) We looked into accounts for the kids, but their fees are too high and the logistics are a pain the ass. Do you want another account to manage, or another errand to run on Saturdays? No. You don’t.

Third, we pay them interest. The other thing about an actual savings account is that interest rates are so low (thanks, Janet Yellen! No, seriously, thank you) that the kids won’t actually understand how compounding actually works, because they just won’t see enough interest income to actually mean anything to them. So I pay them an absurdly high (by market standards) interest rate of 10% per year, and we compound it weekly so that they can see the benefit of it every week, alongside the weekly allowance deposit. (And no, you can not deposit money with me.)

Finally, we act as the ATM. When they want to buy something, or need money for a weekend outing with friends, they ask us for it. We just mark a withdrawal on the spreadsheet, and it helps all of us keep tabs on what they’re spending their own money on. If they’re gifted anything, or earn money on the side through odd jobs, they deposit it with us, because they know it will earn interest.

I have no idea if these tactics will have the desired outcome as the kids grow up and head off to college. Because after all, like most of parenting, we’re just running a long term experiment without a control group.