PARENTS who decide that the time has come to teach their children about money usually begin by opening savings accounts. The kids are intrigued at first by the notion that a bank will pay them for doing nothing, but their enthusiasm disappears when they realize that the interest rate is minuscule and, furthermore, their parents don't intend to give them access to their principal. To a kid, a savings account is just a black hole that swallows birthday checks.
Kid: "Grandma gave me twenty-five dollars!"
Parent: "How nice. We'll put that check straight into your savings account."
Kid: "But she gave it to me! I want it!"
Parent: "Oh, it will still be yours. You just have to keep it in the bank so that it can grow."
Kid (suspicious): "What do you mean 'grow'?"
Parent: "Well, if you leave your twenty-five dollars in the bank for just one year, the bank will pay you seventy-five cents. And if you leave all of that in the bank for just one more year, the bank will give you another seventy-five cents plus two and a half more cents besides. That's called compound interest. It will help you go to college."
The main flaw in such saving schemes is that there's nothing in them for the kids. College is a thousand years away, and they probably think they'd just as soon stay home anyway. Indeed, the true purpose of such plans is usually not to promote saving but to prevent consumption. Appalled by what their children spend on candy and video games (or, rather, appalled by the degree to which their children's profligacy seems to mimic their own), parents devise stratagems for impounding their children's resources. Not surprisingly, kids quickly decide that large sums aren't real money and that all cash should either be spent immediately or hidden in a drawer.
To avoid this problem with my two children, I started my own bank. It's called the First National Bank of Dave. I set up an account for each child, using the same computer program I use to keep track of my checkbook. Because I wanted my kids' deposits to grow at a pace that would hold their attention, I offered an attractive interest rate -- five percent a month. Compounded, that works out to an annual rate of more than 70 percent. (No, I don't accept deposits from strangers.) Allowances are deposited automatically on the first day of each month. The kids can make other deposits, or withdrawals, whenever they like.
The Bank of Dave, which has been in operation four years, instantly turned both my children into ardent savers. My son still comes to me with change he has found on the floor of the car, saying, "And credit this today." Both kids' accounts grew so fast that after two years I had to roll back my monthly interest rate to three percent. The kids squawked when I announced the change, but they nodded solemnly when I explained that the law of supply and demand applies even to the supply of money. The kids help me calculate their interest -- a useful lesson in averaging and percentages. I give them unlimited access to their funds, no questions asked, and I provide printed statements on demand.
The high rate of interest is not the only attractive feature of the Bank of Dave. Equally important from the kids' point of view is that their accounts belong to them. When they save, they reap the benefit; when they want to spend, they don't need permission. Children who have no control over their own funds have no incentive not to beg for money and then squander every dollar that comes into their hands. If your own income consisted solely of what you were able to beg from a fickle and inscrutable boss, you would wheedle too.
The way to help children become rational consumers is to give them more control, not less. Before we go on vacation, I'll usually give my kids an extra twenty bucks or so, which I deposit in their accounts. I tell them that they can spend the extra money on a T-shirt, save it, spend it before we leave, or do anything else they want with it -- but that while we are on vacation, they won't receive any additional pocket money from me (except in the form of communal purchases considered by custom to be vacation entitlements, such as candy, ice cream, movie tickets, and so on). Because any money they spend starts out as theirs, not mine, they think twice before throwing it away. In a souvenir store on Martha's Vineyard a couple of summers ago my son quietly studied the unpromising merchandise while a friend of his loudly cajoled his parents into paying five dollars for a toy tomahawk, which fell apart almost before we got back to the car. My son ended up spending thirty-three cents for an unopened geode, which he later opened by whacking it with a hammer -- a good value, even from my jaded perspective. If he had been spending my money instead of his, he undoubtedly would have wanted a toy tomahawk instead.
Lately I've been thinking that it might be interesting to teach my kids about the stock market. The problem is how to do it in a way that gives them a reason to care about the results. Among the difficulties: transaction costs make it silly to buy and sell small numbers of shares; imaginary trading is no fun; and giving a nine-year-old discretionary authority over a real portfolio would be crazy, not to mention illegal.
I think I've hit on a solution: the Dave Stock Exchange. It will reside in my computer, alongside the Bank of Dave, and will deal in derivative securities -- stocks that rise and fall in lockstep with real stocks but are denominated in pennies instead of dollars. Thus on a recent day a share of Intel would have traded on the D.S.E. for eighty-one cents instead of eighty-one dollars, and a hundred shares of McDonald's could have been had for $48.50 -- the price of a single share on Wall Street. I will serve as the market-maker for all the stocks traded on my exchange, so that no real shares will have to be bought or sold. I'll start my kids with stakes of, say, a hundred dollars each. They will be able to invest this money as they wish, and to make additional investments (or liquidate their positions) whenever they like. They will be able to monitor their holdings -- from minute to minute, if they choose -- using any of a number of portfolio-tracking utilities available online. The stocks will be imaginary, but not to them. If they sell fifty shares of Microsoft at $1.43 apiece, I will pay them $71.50 -- money that will be theirs to reinvest or spend.
The only problem with this plan -- and the reason I haven't implemented it yet -- is that the rate of interest currently offered by my bank is more than four times the historical return on stocks. Any rational investor would close out a stock-trading account immediately and throw the proceeds into the Bank of Dave. As my system is set up at the moment, there is no incentive for my kids not to keep their entire net worth in cash.
One solution might be to place a limit on the size of interest-bearing accounts in the Bank of Dave. Funds over a certain threshold -- $200, say -- could be swept automatically into a brokerage account at Dave & Co., where the money could either be invested in securities or left to earn interest at money-market rates. Another option might be simply to let the Bank of Dave die a natural death. This is already happening in the case of my daughter. She is a teenager now, and has decided that she needs the privacy afforded by a real bank account. She has negotiated an increase in her allowance to compensate for the interest she will be giving up, and she has ordered checks. I view this as a healthy development. A real checking account is useful, and I can't afford to keep paying three percent a month to someone who babysits.
Children are instinctive capitalists. If given enough leeway, they quickly become shrewd managers of their own finances. When parents fail in their efforts at fiscal education, it's usually because for reasons of their own they have managed to make saving seem punitive and dull. Money is fun, and it's almost entirely self-explanatory. The only way to teach kids to adopt a long-term perspective is to give them a short-term incentive for doing so.
Illustration by David Hitch