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In 2007, the Bank of Dad opened its doors when our five year-old daughter opened an account. Wanting to learn more about how to teach financial literacy to my children, I had picked up “The First National Bank of Dad” by David Owen [affiliate link]. Over the years I’ve refined my approach but mostly kept the following three principles that Owen detailed:
- Savings accounts earn 5% per-month, compounded monthly
- Teaching self-control with money requires having control
- Weekly allowance
In addition to these core principles, I’ve added the following:
- One-to-one matching of Roth IRA Contributions
- A weekly book group/discussion
Mega-Yield Savings Accounts
Imagine you’re a child. It’s your tenth birthday, and grandma and grandpa have given you $50. You deposit it into a high-yield savings account offering 2%. After one month, you have $50.08. If you wait for a whole year–a veritable eternity for a child!–you’d have $51.01. Wow. A whole extra dollar. And a penny. In a year. A shiny tin of Pokemon cards for $18 is totally not tempting. </sarcasm>
You see the problem. On a child’s timescale, saving using a normal bank account is glacial. The Bank of Dad shifts the child’s perspective with warp-speed compounding. Let’s jump the rate to 5% monthly, nearly 80% annual interest. In one month, $50 turns into $52.50. In one year it’s $89.79. You’ve nearly doubled the original gift from your grandparents!
The Pokemon temptation isn’t gone, however, because you are still a child. You compromise and decide to only get one tin of cards instead of two. In a year your $32 deposit in the Bank of Dad will be $57.47. Wait, hold on. Buying Pokemon cards now instead of later cost more than just $18. There was an additional $14.22 of lost interest. Wow. That’s almost as much the cost of another tin of Pokemon cards. Maybe waiting a couple months and enjoying the Pokemon cards you already have isn’t such a bad idea.
And therein lies why the Bank of Dad needs to pay significant interest, like 5% per-month, to teach the power of compounding. The following chart illustrates the difference between 5% per-month and 2% per-year interest:
It’s Not About You
So what do you let your child spend their money on? Anything they want. For a child to learn how to control money throughout their life, they actually need control now. You’ll be tempted to “help” your child navigate “bad” financial decisions–really? Pokemon cards?–but don’t do it. They need to make “mistakes” to learn from them and experience the hedonistic treadmill themselves. Avoid even the gentlest nudges (*cough* lectures *cough*) about saving or spending money wisely. If the Bank of Dad is paying 5% interest-per-month then they’ll learn all of that without you saying a thing.
Resist the temptation to push them to do “good” with their money, even if you know in your heart-of-hearts that it’s a “good” goal. If you push your kids to save for college, tithe religiously, or any other “good” goal, what they’ll learn instead is that, again, they aren’t really in control. Demonstrate by example why these “good” goals are a necessary part of the good life. Push them to do it and they’ll more than likely learn the wrong lesson.
The Bank of Dad pays a weekly allowance. Learning about money requires having money. Without money, it’s just an abstract theory. Weekly allowance gives weekly opportunities to learn about money.
How much should you pay? I vary it by the child’s age, with raises on birthdays providing another reason to be excited about making it another time around the sun. Our Bank of Dad starts paying a weekly allowance of $.25 on their fourth birthday, raising it by $.25 each birthday. Every one of my children was super excited to start getting allowance. It’s only a quarter, but it’s MONEY!
What about chores? Don’t link allowance to chores. Why? Imagine you implemented allowance connected to chores and little Johnny decides the allowance just isn’t worth it and refuses to do the chore. What now? In our family, chores are required of all children and are not optional. If they’re not optional but connected to allowance, isn’t it just a charade?
That said, if it’s an exceptional, optional chore or a chore that you would hire out like mowing the lawn or babysitting, you should consider offering the same level of pay to your child if they choose to accept the chore. But remember, the chore is optional and they could refuse it.
Oh, and about babysitting. In our house we pay not only the child who is doing the babysitting but also the children that are being babysat, although at a lesser rate. Why? The idea is to incentivize good behavior. If they misbehave during the session they risk forfeiting part or all of their portion.
Paying an allowance means the child is responsible for their own discretionary spending. They want those Pokemon cards? They can buy them if they have the money. The latest gizmo all the kids at school have? Same. Placing these purchasing decisions in the hand of your child is reason enough to institute an allowance. No more nagging!
So, what’s not covered by allowance? In general, you should pay whenever you wouldn’t accept the child’s decision to forgo or go cheap on a purchase, or it’s your decision that a purchase is necessary. For example, does little Johnny need to take a present to his classmate’s birthday party? You pay, since you probably wouldn’t want Johnny choosing to skip the present or go cheap. However, a birthday present for a sibling? The child should probably pay. Is it a family outing to the county fair and you’ve decided the whole family is getting ice cream? You pay because you’re the one making the purchase decision. But if the child wants to try their hand at winning that oversized stuffed bear in that carnival game? Child child pays. The rule of thumb is who is controlling the purchase. If it’s you, then you pay. If it’s the child, then the child pays.
Closing the Bank of Dad
Looking at the previous chart, it becomes clear that at some point you’ll be insolvent if you keep paying this kind of interest to your kids. If you were to continue the Bank of Dad until your child was 40 years-old, you would have paid out a little more than $2,000 but over $30 billion in interest. Even Bill Gates can’t keep this up.
So at what point do you stop paying interest? We stop at 13. At that point we start the Brokerage of Dad, which I’ll cover in a separate post. This age is also right at the point where a child can start earning money which can quickly overshadow both allowance and interest.
The Fine Print
Having operated the Bank of Dad for 12 years now, here are some additional observations:
- Paying allowance and interest could cost you around $2,500 if you do it like I did. This of course will vary depending on how much they spend or additional money they are able to deposit
- We start their savings account at age four and end on their thirteenth birthday
- Any money can go into the account: allowance, birthday money, earned money from lawn mowing, etc.
- Only direct descendants can open an account. Some folks think it’s hilarious to ask to open an account when I tell them about it. I’m sure they are a riot at parties.
- A four-year old with physical money is a recipe for disaster. You’ll be finding loose change spread around the house. When they are young, I keep their allowance in a ziplock bag. When they get older, we buy them a simple lockbox so they can manage it themselves.
- Monthly compounding, monthly accounting. I typically do the accounting with them on the first Sunday of every month. I’ve found that weekly is too much overhead. Set a calendar reminder so you don’t forget.
- When the amount of money gets large, I opened an online child savings account in their name. Otherwise we would have ended up with a lot of cash on hand, which could be problematic.
- I keep a notecard to track their current balance and interest earned. This helps them see the value of compounding.
So now what?
Now that they’ve learned the power of compounding interest, what’s the next step to teaching financial literacy? I first instituted a book group with my older kids, exposing them to a wealth of financial topics. Additionally, when my oldest started earning money as a lifeguard, I instituted a matching contribution to her Roth IRA account, to encourage both working and saving for the future. I’ll cover both of those in future posts.
- According to https://www.valuepenguin.com/banking/average-bank-interest-rates the national average interest rate is 0.09% so that $50 will have only gained $.54. And if you’re stuck at one of the major banks, you’ll only get %0.01 or $.06 cents.
- Purchases can’t break any core family rules. In our family that means things like no drugs, tobacco, alcohol, pornography, etc.
- We’ve had success opening online child savings accounts at CapitalOne. [Affiliate Link]