More importantly: at what age is my daughter old enough to understand compound interest?by Duncan Weldon / May 18, 2018 / Leave a comment
10p per year of age? £1 per year of age? It’s time to do some research. A couple of weeks ago, my eldest daughter told me that when she was older she would have “a big house and a fast car.” After a moment’s pause, she further noted that “it would probably cost a lot of money”. When I enquired as to where she would get the money from, she gave me the kind of dismissive look that only a five-year-old can and replied, “I’ll borrow it from a bank, silly.” Suddenly, the deep cultural roots of low Anglo-Saxon economy household savings ratios made sense to me. This stuff starts early. Partially inspired by this exchange, I’ve decided it’s time to start some financial education. The basic aims are to get her more familiar with money, to demonstrate the value of saving and to encourage general good financial behaviour. My earlier efforts in this regard may have been counterproductive. I encouraged her to pick a horse for the Grand National and placed a £2 bet on her behalf. Tiger Roll came in at 10/1 and the next weekend saw a trip to the toy shop. In hindsight, “gambling is a really good idea” possibly wasn’t the ideal first message to impart. Giving her weekly pocket money, and allowing her to make decisions, seems a more promising starter point than encouraging her to read the Racing Post. But how do I begin? A quick review of online parenting forums, and an appeal for guidance on Twitter, have left me with more questions than answers. One very common response was “why does a five-year-old need any money at all?” A fair question. The current situation is that birthdays, Christmas and overly-generous grandparental visits aside, her only discretionary consumer spending comes in the form of natty magazines, packaged with a couple of dozen stickers (which invariable end up stuck on the floor) and some sort of plastic toy, (which has a half-life of approximately three days). She ends up getting one, paid for by her parents, about once a week at a cost of anything between £3 and £5. This has presented my first quandary. What is an appropriate amount of cash to give to a five-year-old? Suggestions on the internet range from 10p per year of age each week to £1 per year of age each week—or anything, in my daughter’ case, between 50p a week to £5 a week. On the one hand, I’m reluctant to place her at the top of the range but on the other anything less than £4 would mean she couldn’t continue her current consumption patterns. Whilst I would then spend less time picking stickers out of the carpet, I’m not sure an immediate cut to what she regards as her standard of living is the right note to start on. And although £4 a week still feels like a lot of money for a primary school student, it is possible I’m suffering from a case of what economists call money illusion—the tendency to think in nominal (i.e. cash) values rather than real (i.e. inflation adjusted) terms. A quick check of the ONS consumer price index data reveals that £4 today is the equivalent of about £1.85 when I was five. The second question is on the vexed issue of “conditionality.” Should I go for a universal basic income approach of a flat payment every week? Or is it best to tie the payments to certain behaviours? In an ideal world, I’d prefer to take the “jobs guarantee” approach over UBI. I, as parent, would act as employer of last resort and pay her a weekly wage in return for certain tasks. (I am relatively sure that five-year-olds are not entitled to the minimum wage and I don’t believe I’d have to make any National Insurance contributions.) The problem though is that there are few jobs you can give to a five-year-old which don’t ultimately make more work for yourself. I suspect the answer is to tie the payments to good behaviour and basic things, like keeping her room tidy, rather than specific chores. The final question, then, is this: how to encourage saving and delayed gratification? Fund Manager Toby Nangle wrote the book, or the blog post anyway, on this. The Nangle scheme—as initially described in 2015—is relatively straightforward: the children get 10p per week per year of age but have the option to put it in a “bank,” which pays 10 per cent interest per week. As Toby wrote at the time, his children reacted to the bank by delaying spending and building up £5-6 balances. At first glance, it feels like Toby has found the ideal solution. Perhaps my five year old could be encouraged to stop buying magazines that hold her attention for an hour or so and instead to save up for bigger—and more meaningful—purchases? (Although perhaps not the “big house and fast car” straight away.) But a year later, Toby followed up with an update. “Fast forward a year and it’s rate cut time. Why? Because, basically, my 6 year old gets it. From his 60 pence a week pocket money he has, with the help of compound interest, amassed a fortune of £50, giving him an unearned income of £5 per week and rising that he sinks back into the Bank. My 8 year old meanwhile has maintained both a balance of between £2-15, and a healthy scepticism of the value of saving for its own sake—preferring to save for something specific, buying it, then starting again.” £4 a week pocket money compounding at 10 per cent a week (and I can see why Toby prefers 10p per year of age per week) would mean, if the five-year-old decided to save for a year, I would owe her just over £6,200. That definitely feels too high for a six-year-old. In fact, 106 weeks after the scheme began, I would owe her over a million pounds. At which point she could conceivably afford her fast car and big house but would more likely learn an important lesson about counterparty risk and the importance of diversification when I defaulted on my obligations. So, my proposed scheme is £3 per week conditional on good behaviour, which will be topped up by an additional pound to £4 in any week in which she doesn’t spend any money. In other words, I hope to encourage good saving behaviour whilst also limiting my own exposure to a maximum of £208 a year. But like all economic experiments, this one may end up being abandoned in failure. Especially if the stickers keep ending up on the carpet.