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Do allowances teach your child budgeting or entitlement?
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Many researchers, but not all, think that allowances are a good way to teach children the importance of budgeting but they need to be accompanied by frequent conversations with their parents. - photo by Daniel Bendtsen
Lewis Mandell got an allowance as a kid.

So its natural he gave his daughter an allowance too no strings attached. Mandell, an economist who specializes in financial literacy, held to the conventional wisdom that allowances give children valuable practice in managing money.

But if he repeated his parenthood, he said hed do things differently. He likely wouldnt have given his daughter an allowance at all.

Thats because her teenage years were spent in the 80s, well before Mandell helped conduct financial literacy tests on thousands of high school seniors. Working with the nonprofit Jump$tart Coalition, Mandell conducted the first tests in 1997.

The results were surprising.

Honestly, when we asked that question, I had a very traditional set of expectations," he said. "I thought that giving a kid an allowance was good for a kid, because if nothing else, it taught them how to budget.

Instead, receiving an allowance barely had made a difference in the high schoolers ability to pass the financial literacy test. In fact, those who received an allowance did worse. Those who received an allowance not based on chores? The worst scores of all.

Mandell did more research and discovered that other researchers had similar results. He found another significant correlation: teenagers who receive an allowance are less likely to work outside the home.

When Mandells survey was revamped in 2008, now with backing by the Federal Reserve, it studied a new variable: did teenagers working outside the home affect their financial literacy? The differences werent profound, but those teenagers who never worked scored worse on 4 out of 5 sections of the test.

That has led Mandell, now a professor emeritus at SUNY-Buffalo, to think that allowances might do more harm than good. He prefers the idea where parents pay ad hoc for the individual requests and needs of their children that way, they're forced to have the regular conversations kids need to learn about being smart with money.

If they want money to buy the new iPhone, you can say 'OK, you have an iPhone 5. Tell me why the iPhone 6 is worth $500 extra to you,'" Mandell said, stressing that kids are forced to think about what's a reasonably smart purchase.

It's those sorts of conversations that all financial advisers believe is key to develop good spending habits.

Conversations = understanding

Investment firm T. Rowe Price conducted a study this year in which researchers surveyed parents and their children about issues of money around the home.

The parent who didn't have frequent conversations about money with their kids had a big impact on the confidence children have in handling money. Only 14 percent of those kids said they felt knowledgeable about handling personal finances. Nearly half, 46 percent, of kids who did have frequent conversations about money said they could handle money well.

And yet only 21 percent are having frequent discussions with their kids about finance. According to T. Rowe Price's data, parents are afraid their children will worry about money or are too young to understand.

But Judith Ward, a senior financial planner for T. Rowe Price, says that attitude is a mistake.

There are ways you can do it that its age appropriate, and its helping them in terms of financial literacy, Ward said.

She said talking about money is vital, especially as kids today are more likely than ever to enter their 20s with student loan debt. Ward said parents should talk to their kids as early as possible.

If youre at the grocery store with your kids and youre comparison shopping, bring them into the conversation," she said. "Have them try to find the cheapest cereal. If you use coupons, have them find the item that matches the coupon, but explain to them why youre using the coupon."

Pros and con

Unlike Mandell, Ward believes allowance has value as a teaching tool.

Allowance is a safe way to give kids a little bit to spend, theyll maybe spend it on something theyll regret later, but its a good lesson," Ward said.

The study from T. Rowe Price backs that up. Kids who who received an allowance were twice as likely to say they were knowledgeable about managing money as those who didn't.

But Mandell and Ward can both agree on one thing: if allowance is given, it's only as good as the conversations parents are having.

In the T. Rowe Price study, when the experience of using money was coupled with conversations, it had the biggest impact on how knowledgeable kids felt managing money (68 percent to 0 percent). The real value, Ward says, is that their parents are able to give them advice about something tangible.

Mandell does think that allowance could help stir those conversations, but unfortunately, too many parents are financially illiterate themselves and merely pass down poor spending habits to their kids.

If allowance is given, Mandell advises that parents tie it to chores. That way, kids learn the value of a dollar and good work ethics.

When kids are given an allowance with no-strings-attached, "it sets up an notion of entitlement," Mandell said. "Some studies show they dont do as well later in life. They have almost a welfare mentality."

Some fear, however, that tying allowances to chores could only harm work ethics by not developing the intrinsic responsibility that being helpful doesn't always come with personal reward.

That's a concern also shared by author Beth Kobliner, who's a member of the President's Advisory Council on Financial Capability.

"Family chores are more about the responsibility of being part of a community, not about hitting up Mom or Dad every time the dishwasher needs emptying," Kobliner wrote.

Her advice? Require regular (unpaid) chores of your kids. But allow them to receive allowance by doing other household tasks that might be more ambitious ones they wouldn't normally be expected to do.