Investing A Young Child’s Allowance

When I was young, my best friend’s family used to give him and his siblings an allowance based on their age (I didn’t have an allowance, mostly because there simply wasn’t the money for it). When you were ten, for example, you would multiply your age by a certain factor (in their case, \$1) and that was your weekly allowance, \$10. You would continue to receive an allowance until your sixteenth birthday, at which point you were considered able to work a part time job for money.

One day, my friend made an astute observation: he didn’t recall receiving an allowance until he was about six years old. What about the years before then? His parents said that he didn’t do any chores at such a young age, but he was able to reason with them that he was learning to do the chores and, as a toddler, he also provided ample entertainment for guests. Although this was a good argument, it didn’t really earn him his “back allowance” that he wanted so desperately.

Now I’m a father, and my child just had his first birthday. I consider an allowance to be a great idea for money management, so I’m going to institute a weekly allowance for my own child. My wife and I decided that two dollars per year per week is a good rate, so that means that technically my child should receive his first allowance of \$2 today.

Since I don’t actually plan to start giving him a real allowance until he’s six or so (at a younger age, money is conceptually challenging), I have decided to invest this money for him for the first five years of his life and then let him make decisions about what to do with it when he is older.

So let’s look at what I have to invest for him. For the first year, I will add two dollars to his investment pool; during year two, it’s \$4 a week; during year three, it’s \$6 a week; during year four, it’s \$8 a week; and during year five, it’s \$10 a week. After that, my son will receive his allowance and I’ll give him the opportunity to determine if he wants to keep the money and spend it or invest it.

My goals for investing are simple:
1. I want to minimize the risk so that there is a less than one percent chance that his balance at age ten would be less than if I put it all into a piggy bank.
2. I don’t want to invest extensive effort into specific choices. In fact, I’d like to set up an automatic deduction for this expense.
3. I’m not going to contribute a minimum balance to this in order to qualify for a particular type of account. This will be entirely his money. Once it leaves my hands, it’s his for eternity.
4. I am willing to pay small amounts of tax on the money out of my own pocket to shield some of the growth.

Let’s look at our baseline. If I simply keep it in a piggy bank (the worst option), he will have \$1,560 in cash on his tenth birthday which will only grow if he chooses to add more to it. This is not a realistic option.

If I were to take it to the local bank and put it in a savings account there, which offers a 1% true interest rate compounded quarterly. By putting his allowance in there, the balance on his tenth birthday would be \$2,324.96, according to my kitchen table arithmetic.

How about a high-yield savings account, such as the one offered by HSBC Direct? It offers a 5.05% APY and is compounded monthly, which comes out to a true interest rate of 4.936%. Given the same numbers, the total with this investment is \$2,964.72.

I think the idea of using a high-yield savings account is a good one until he reaches the \$1,000 threshold, just before his fifth birthday. At that point, whenever the account reaches \$1,000, I invest in a certificate of deposit that matures prior to his tenth birthday, I can reach a total of \$3,050 with very little additional risk. This can all be handled fairly automatically, with very little risk.

I think that a mix of high-yield savings with certificates of deposit offers the best plan for earning some money on my child’s savings. Upon his tenth birthday, he’ll have some money to determine what to do with, and it will be a good time for him to learn about investments on his own. I will be able to hand him a solid amount of money that is actually his from his allowance.