Allowing your kids to make mistakes with money

One of the hardest things for me as a parent is to watch my kid make mistakes and suffer the consequences. Now, I do my best to stop her from making any really big mistakes with big consequences — I make sure her seat belt is on, I don’t let her talk to strangers online, and I make her wear a helmet when she is riding a bike. However, when it comes to money, I am committed to letting her make mistakes, suffer the consequences, and hopefully learn. The consequences of money mistakes for a tween feel tragic, but they are still fed and have a roof over their heads. The same mistakes at 21 or 41 can get you in a lot bigger trouble.

For the last two weeks or so, the Child has been earning her own money to buy extras with. That includes snacks (we are no longer buying junk food, but of course, she is welcome to snack on apples for free), and in-app purchases. She gets 5% interest on any money she has left at the end of the day. She can earn $2 per day by doing her schoolwork and chores, but she can get overtime for doing extra chores.

With a 5% daily interest rate, the winning strategy is to accumulate some money, say $100, and then “retire,” making $5 per day just in interest. And because of the magic of compound interest, getting to $100 would take her just 25 days of not spending. In just 66 days of not spending, she can accumulate $1000, generating $50 per day and be completely financially independent! (OK, if she really got close to that, I would reduce her interest rate.)

Despite these amazing possibilities, for now, the Child is behaving like a typical consumer. She is doing a good job, “going to work” every day and earning her $2. So far, she has not elected to work overtime. Almost every day, some shiny in-app purchase tempts her, though, so her account fluctuates around $5. At the end of the month, some of her memberships will expire. I am not sure she will have the money to renew them. She also loudly complains about the lack of junk food in the house. Still, because we only shop about once a week, she has trouble accumulating enough money to buy enough junk food to last her the week (not that I am sad about this. I don’t really want her to buy junk food).

Of course, her behavior is very typical for many young (and not so young) adults. I know plenty of 20-year-olds who spend their weekly paycheck on the newest electronic or at the bar, and at the end of the month, they don’t have enough money to pay rent. Or 30 years-olds who have shiny cars but find it impossible to save for a downpayment on a house. Or 60-years-olds who have pulled out the equity in their home so often that they are still looking at another 25 years of mortgage payments and have no retirement savings to speak of.

At each stage, it becomes harder for a parent to watch their child suffer, and we all know of middle-aged adults whose parents still “help” them financially. I don’t want that for the Child. So, I will listen to her complain about the lack of junk food in the house, and I will let her memberships in her favorite apps expire and hope she learns this lesson early so in 10 years, I don’t have to worry about her becoming homeless because she couldn’t pay her rent.

If you have kids out of the house, now is a good time to stop “helping” them financially. That doesn’t make you a bad parent. They will feel better about themselves if they can figure out how to manage their own finances. If you don’t feel you can stop “helping” abruptly, you should plan with them on how you will gradually decrease how much money you give them and stick with the plan. Being a parent is hard work, but ultimately the goal is that your adult child truly becomes independent from you, and financial independence is a key step in that journey.

Teaching money skills to tweens and young teens

As the Child is approaching the ripe old age of 12, it is time to teach her to the skills she will need to be able to manage her money as an adult. As every teacher will tell you, to design a good lesson, you need to start with learning objectives. So what should a tween or a young teen know? Most tweens are ready to be introduced to all the complexities of money that they will need as adults. The amount of money they will earn, manage, and spend is, of course, smaller than those an adult would manage. You will also need to “speed things up” so they can see their money grow in a time frame they can follow. Earning 10% interest per year might be a reasonable return on investment for an adult, but a 12-year-old would have difficulty noticing such growth. Here are some basic money management skills you might want to teach and ideas on how to do it.

To make money, you have to do something. Set up a list of “jobs” that your child can do to earn money. We are allowing the Child to make money for doing each of her school subjects as well as doing chores and getting physical activity. She can earn about $1.50 a day for her “work” (we are probably breaking some minimum wage laws here). Each task she has to do is worth 25 cents. She gets a completion bonus of 50 cents if she finishes all her tasks for the day.

Consider overtime pay to give your tween or teen a chance to earn extra money. We pay double rate for additional chores. Also, consider performance bonuses for jobs well done. We pay significant bonuses for exceptional school performance. The Child made $10 this morning by getting an A on her Spanish test.

Some parenting books will tell you that kids should not earn money for chores but should have a set allowance because they should learn to aim for internal motivation. The child shouldn’t strive to get an A on the test to earn a performance bonus but to get the satisfaction of a job well done. While I understand this argument, I don’t think I can expect more from my child than I expect from grown-ups, and we all appreciate getting paid for our work, so I am OK with the Child being motivated by a performance bonus.

Once you have some money, you can get your money to work for you. There are two ways to think about discretionary income: extra money to spend or a tool to help you on your financial independence journey. Here is an example from the adult world. Two families get a $5,000 end-of-year bonus. Family A decides to upgrade their TV and their cell phones. A year later, they are craving an even bigger TV and even newer cell phones. Family B puts their $5,000 in investments. A year later, they have $6,000. We all know how this goes after 20 years. The family with the new TV will have no financial cushion and will fear retirement. The family who invested every year will be sitting on a couple of million dollars and will be in a position to choose if they want to work or take a trip around the world.

Consider paying interest to your child on the money they haven’t yet spent. For a tween, you might consider paying interest every day. As your tween grows up, you can move to weekly or monthly payments. Our 11-year-old will earn 5% each evening on any money she has left at the end of the day. If your child is a natural saver, use lower interest or longer intervals. The power of compound interest is amazing, so be careful not to overcommit.

You can’t buy everything. An essential adult money skill is the ability to prioritize and save for bigger purchases. To give your tween or teen practice, you need to stop buying everything for them. Of course, you shouldn’t stop buying anything they need, but you should cut back on funding their wants. We have stopped buying snacks and online subscriptions. The Child is generating a very long list of things she wants, and I am sure the list will keep growing as she discovers the power of money. Her many wants create the need for her to prioritize. She will also learn (we hope) that if she wants a $10 membership, she can’t spend all of her daily earnings on candy.

Debt is bad. I know some people will disagree, but in my opinion, all debt is bad. Really, really bad. And consumer debt to buy optional items is truly evil. Unfortunately, for most kids, the only way to teach this lesson is to let them get into debt and experience the pain for themselves. And for the pain to be real, you need to charge interest and have consequences if the debt is not paid on time.

One option is to secure the debt. The kid needs to give you something of value, which becomes yours if they don’t pay you back. I know I am not strong enough to stick to this rule, though, so instead, we are doing unsecured debt like on a credit card. The Child is allowed to borrow money at 10% interest per day. Her credit limit is $10. If she exceeds the limit, she will not be able to use screens or spend anything until her balance is under $5. An older child should have the ability to get into more significant debt which will take longer to get out of.

Those are the four main lessons about money that I think every adult should have mastered. What are you teaching your kids about money? How are you teaching it?