The Last Word on Kids and Cash

Editor's note: This story has been updated since it originally was published in 2008.

Years ago when my son was 25, he called me -- sounding a bit testy. John had just read a story in Kiplinger's about a young investor named Deirdre, also 25, who had amassed more than $100,000 in Vanguard index mutual funds. "You write about kids and money," John said accusingly. "How come you never told me about mutual funds?"

I patiently explained that John's Roth IRA -- which my husband and I started for him when he was in college and to which he has regularly contributed since he graduated -- was in fact invested in a Vanguard index mutual fund. One reason Deirdre had managed to accumulate all that money (aside from the bull market of the early 2000s) was that she lived at home with her parents and socked away more than 60% of her salary.

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What John learned from this episode was a little more about the stock market and the value of thrift -- and that he should pay closer attention to his IRA statements. For me, it confirmed several truisms that I have learned from more than 15 years of writing about kids and money: First, no matter how old they are, your kids will come to you for advice. Second, nothing you can tell them is too basic. Third, a little information goes a long way.

Because I advise parents about how to raise money-smart kids, I've always felt a weight of responsibility to do the same for my own three children. People often assume I have a magic formula for calculating the right amount of allowance (I don't, but I have some strong opinions), or that my kids are stock-market whizzes (obviously, they're not). But the older two got through college without overdrawing their checking accounts or running up credit-card bills, and the youngest is following in their footsteps. And to be honest, I've learned as much from them as they've learned from me.

Thanks to them, and to the thousands of parents with whom I've spoken and who have written to me over the years, I've come up with a set of practical rules for raising money-smart kids at every age. They may be different from what you've read elsewhere, but they work.

Ages 3-5: big-picture years

Give a 3- or 4-year-old a choice between a nickel and a dime and he'll choose the nickel because it's bigger. My rule for preschoolers: Keep things simple and don't expect too much. If your daughter thinks that "everything costs $68," as a fretful parent once complained to me, don't worry. You've accomplished a lot if you can teach children this age that money can be exchanged for other things.

Encourage them to put coins in a vending machine or pay the ice-cream man. They can play with fun savings banks, learn the difference between pennies, nickels and dimes, or collect state quarters. The more hands-on the activity, the better.

Don't push your kids into things they don't understand or can't appreciate. For example, youngsters this age live in the moment; for them, a week might as well be a lifetime. So asking them to save for college, although a worthy goal, isn't realistic. But they can save their birthday loot for a trip to the dollar store, where they can choose -- and pay for -- something they want.

Ages 6-7: Time to Start an Allowance

Kids will spend unlimited amounts of money as long as it's yours. When their money is on the line, they've got skin in the game, as one of my regular correspondents is fond of saying. The best way to let them start making their own decisions is to give them an allowance, and this is a good age to begin.

For one thing, kids are learning about money in school, so they understand that four quarters equal one dollar. Also, they have a more mature understanding of money in the abstract, so they have some sense of how much that dollar will (or won't) buy, and they can plan further into the future. Think of it as stealth budgeting.

How much to give? Start with a basic weekly allowance equal to half the child's age. I know, I know. Some people recommend giving a weekly allowance equal to a child's age. But in the real world, I've found that parents often balk at giving a 6-year-old $6 a week. Hence, my half-age rule. If you'd like to bump that up, feel free.

Now for the even bigger question: Should the allowance be a quid pro quo for doing chores? My advice: No, it shouldn't. I'm in the camp that believes kids should clean their room or help unload the groceries because they're asked to, not because they're paid. Plus, over the years I've learned that many parents have a tough time keeping track of whether their children have actually done their assigned chores that week.

But an allowance shouldn't be a handout. My rule: Tie the basic allowance to "financial chores" -- spending responsibilities that the kids take over from you. You could start by having them pay for their own collectibles, for example, or refreshments at the movies. The beauty of the system is that as your kids get older, you can expand their allowance and their responsibilities.

To make the connection between work and pay, give your children the opportunity to earn money by doing extra jobs, such as vacuuming the family room, raking leaves or washing the car, and pay for each task as it's completed to your satisfaction. That's easier for you to monitor than a week's worth of chores. Remember rule number one: Keep things simple.

Ages 8-10: Bank on It

Help your kids open their own savings account. Of course, you can start saving on their behalf when they're much younger, and they probably have a wad of birthday cash stuffed in their sock drawer. But now they're mature enough for you to introduce how a real bank works. Even at this age, kids may be horrified to see their money disappear. It takes them a while to understand (and accept) that if they deposit, say, a $10 bill, they'll get their $10 back -- but not the same bill.

Should you require your kids to save? That depends. Believe it or not, some youngsters hoard every penny and have to be forced to spend. You can always have them divvy up their allowance into pots of money for spending, saving, charitable giving, even investing. But if you don't want to take the trouble to parcel out the cash, a simple alternative would be to have them save, say, a nice, round 10%, or tithe that amount to charity. And you can always encourage kids to save by matching what they put aside -- your very own family 401(k).

Another strategy that works: Have your children save toward a goal, whether it's a toy or a new baseball glove. And when they reach their goal, let them spend their money and enjoy the payoff for their efforts. Saving may be spinach and spending dessert, but as my youngest child, Peter, once told me, "Saving can be dessert, too, if you save for something you want."

Ages 11-13: Parent Power

As you head into the difficult 'tween years, remember this: Parents have power. Despite media hype and peer pressure, kids will listen to you if you have a clear message and deliver it consistently. A young woman once told me that when she was a kid, her parents had a rule about holiday gifts: She and her siblings couldn't ask for something if they had seen it advertised on television. A bit extreme, I thought. But not only did the young woman and her older brother accept the rule, they also passed it on to their younger brother (misery loves company, perhaps?).

Now's the time to build on the foundation you laid when your children were younger. Expand their allowance money to include more discretionary purchases: video games, movie tickets, shopping excursions with their friends. My rule: Kids shouldn't hit you up for 20 bucks every time they head to the mall. Having to chip in their own money puts a natural brake on spending, keeps them from bombarding you with requests for expensive brand-name stuff, and gives them a reason to save for their own iPod.

If you're an investor, introduce your kids to the stock market. They're old enough to understand that owning stock means being part owner -- and sharing in the profits -- of a company whose products or services they use. (In answer to numerous questions I get from readers, investors can make small purchases of stock through Sharebuilder.com, with commissions as low as $4, and MyStockDirect.com, which links to more than 100 companies that sell stock directly to the public.)

Ages 14-15: Stick With Cash

The latest wrinkle in allowances is prepaid debit cards, which are aimed squarely at this age group. Parents are encouraged to transfer money to a child's online allowance account, which the child can access with his card to withdraw money at an ATM or to make purchases online or in stores -- and which Mom and Dad can top up when the money runs out.

My rule: Stick with cash. Even at this age, plastic of any kind isn't as real to kids as money they can see and feel. With a cashless society looming in their future, learning to manage hard currency is more important for children than ever. This is a good time to expand their allowance to include clothing, concerts and other high-school entertainment, plus buying gifts for friends.

It's also time to encourage them to get a job, at least over the summer. Teens this age are permitted to work in offices, amusement parks, movie theaters, restaurants and retail stores. For convenience, you can arrange for them to have an ATM card so that they can deposit and withdraw their own earnings from their own savings account.That's how my son Peter managed his money throughout high school. When he turned 18, I offered to help him open a bank checking account with a Visa debit card. Much to my surprise, he declined. "With a debit card," he said, "it would be too easy to spend money."

Ages 16-18 and Into College: Hold the Plastic

There's a school of thought that says teenagers should get credit cards when they're still at home so they can learn to manage credit responsibly when they're on their own. I disagree -- strongly. In fact, I'm on record as saying that giving teens credit cards makes as much sense as letting them use drugs so they won't turn into addicts.

I'm not against credit cards. I just think that teenagers in general aren't mature enough to manage them. And there's plenty of research to back me up. James Roberts, a marketing professor at Baylor University, has found that young people who use credit cards "are less price-sensitive, spend more, and overestimate their available wealth compared to those who write checks and pay cash." They're also more likely than adults to max out their credit, and they're more susceptible to impulse buying.

Kids this age need to learn about credit, but remember that a little basic knowledge goes a long way. Teens don't realize that a credit card is not free money. They need to know that when you use a card, you're borrowing from the card issuer, which will charge you a high rate of interest.

My rule: Cash is still king. Help your kids open a checking account (and get a debit card) so they can learn how to balance a checkbook -- either by using a check register or online entry -- before they head off to college (co-sign the account if the bank requires it because they're not yet 18). Fund the account with the money they earn from their summer or part-time jobs and will use to help pay for college expenses. Let them know upfront which expenses you'll pay for -- books, for example -- and which are their responsibility, such as food outside the meal plan.

Age 21 and Beyond: Ready to Launch

Once your kids are college seniors and you're confident they've learned to make their spending money last for a whole semester, they're ready to apply for a credit card -- on their own. My rule: Don't put your kids on your accounts or, even worse, co-sign for their obligations. That puts you on the hook if they don't pay up.

If you and your children have been talking about money all along, you'll move seamlessly into adult topics. (See 7 Personal Finance Basics for New Grads.)

Who else are they going to ask for advice on buying health insurance, starting a 401(k) plan -- and, yes, making big bucks in mutual funds? It's even more gratifying when your money-smart kids don't need your help. When our daughter moved 3,000 miles from home to take a new job, my husband offered to subsidize her apartment. Claire declined. "I'd rather do it myself," she said.