Many children first learn the value of money by receiving an allowance. Parents often give their children an amount of money that they may spend as they wish. The purpose is to let the children learn from experience at an age when financial mistakes are not very costly.
A child may receive an allowance each week or each month. The amount is not so important. But parents should make clear what, if anything, the child is expected to pay for with the money.
At first, young children may spend all of their allowance soon after they receive it. If they do this, they will learn the hard way that spending must be done within a budget. Parents should not offer more money until the next allowance is to be paid.
Older children may be responsible enough to budget larger costs like those for clothing. The object is to show young people that a budget demands choices between spending and saving.
Many people who have written on the subject say it is not a good idea to pay your child for work around the home. These jobs are a normal part of family life.
Paying children to do extra work around the house, however, can be useful. It can even provide an understanding of how a business works.
Allowances give children a chance to experience the three things they can do with money. They can share it in the form of gifts or giving to organizations. They can spend it by buying things they want. Or they can save it.
Saving helps children understand that costly goals require sacrifice: you have to cut costs and plan for the future.
Requiring children to save part of their allowance can also open the door to future saving and investing. Many banks offer free savings accounts for young people with small amounts of money.
A bank account is an excellent way to show children the power of compound interest.
Compounding works by paying interest on interest. For example, one dollar invested at two percent interest for two years will earn two cents in the first year. The second year, the money will earn two percent of one dollar and two cents.
That may not seem like a lot. But an investment that earns eight percent compounded yearly will increase one hundred percent in value in about nine years.