Most Americans Pay Their Children an Allowance. Here's Why You Should, Too.

Do you pay your children an allowance? If you do, you're not alone. According to a Harris Interactive poll released earlier this year, approximately 60% of parents with children ages 4 to 17 dole out cash on a weekly basis.

Source: flickr/401(k)2013.

It may seem ludicrous to pay a 4-year-old a weekly allowance, but depending on where that money actually ends up, it could be the best thing any parent can do for a child. Today we're taking a closer look at the Harris poll and considering the real power of a child's allowance.

Poll stats
Harris Interactive polled 2,311 adults on all things allowance-related last December. Though there were trends that emerged along gender and regional lines, the biggest dollar-amount discrepancies in the responses were generational. Echo boomers (known as millennials in some circles) and Generation X respondents were closely aligned when it came to appropriate amounts for a weekly allowance -- baby boomers less so. Take a look:

Source: Harris Interactive 

Oh, to be the child of a Gen-Xer! These parents think children aged 14 to 17 should earn a weekly allowance of $18.80 a week! Interestingly, the poll also revealed that 86% of respondents believe a child should have to earn his or her allowance, and that it should only be paid if the child works for it.

Most importantly, however, is that 90% of respondents thought that an allowance was a good way to teach children about money. In theory, that is absolutely correct. It's hard to understand the power of a dollar if you've never earned one. And while one might argue that a 4-year-old is incapable of understanding this at all, a child of 7 or 8 is not. Financial literacy is a major problem in this country -- in most countries -- and if handing out an allowance can help change that, then by all means we should pay up.

But how many of us truly recognize the power of a weekly allowance? Consider those dollar figures from the poll. Let's take the midpoint allowance figure for each age range -- $5.10, $10.10, and $18.00 -- and encourage our child, Little Susie, to put every penny of it into an index fund. Assuming that Susie gets grounded for two weeks each year and doesn't earn an allowance during that time, she will contribute 50 weeks of savings to her nest egg every year. It will compound annually at the S&P 500's historical compound annual growth rate -- with dividends reinvested and adjusted for inflation -- of about 6.8%.

Source: Author's calculations.

On the eve of her 18th birthday, Susie will have grown her hard-earned allowance into $10,145. if she had simply left her allowance in her piggy bank, she'd only have $7,240. 

But maybe Susie isn't sold on a mere $10,145, so her parents sit her down and show her what it could turn into if she leaves it in the index fund:

Source: Author's calculations.

Provided the fund returns the 6.8% historical figures, even if Little Susie stops contributing any money to her savings, she'll have turned 14 years of allowance into more than $290,000 by the time she reaches retirement. It's not enough to retire on, but it is enough to make a point about the value of saving. 

Will Susie head to college and pursue a degree in economics or finance? Maybe not, but she will definitely understand the power of compound interest, something that will have an incredible impact on her for the rest of her life; say, when she gets her first credit card, pays off her student loans, decides how much to contribute to her 401(k), buys a house, and so on. This is the real power of a weekly allowance. The ability to confer financial literacy, which may be the greatest investment we make.