What’s the Secret of Smart Budgeting?

You’ve probably heard the saying "the devil is in the details," but when it comes to managing your money, just the opposite is true – the more details, the better your chances for success.

I recently interviewed Stephen Spiller, a PhD candidate at Duke, who has a forthcoming doctoral thesis on opportunity cost, and how it relates to the way we spend money. In layman’s terms, opportunity cost is the benefits you miss out on by making a particular choice. Let’s say you get a $1,500 tax refund, and you’re torn between taking a vacation, buying a new couch, or saving for retirement. You decide to buy a ticket to the Caribbean. The couch and the savings represent your opportunity costs (along with the investment income you would have made over time by putting the money toward retirement). When you’re aware of your opportunity costs, you can spend scarce resources more efficiently.

Spiller’s thesis argues that people pay attention to opportunity costs only when they bump up against a "constraint." What they spend today is meaningful only as it relates to what they can’t spend tomorrow – i.e., if I buy this pair of jeans today I won’t have money for the power bill due next week.

This is where the details come in. People who budget typically plan out expenses for the week, the month and sometimes the year. For instance, I use an online budgeting software called Mvelopes.com (I also write a column for the site), which allows me to set aside money every month for future expenses. Let’s say my homeowner’s insurance costs $1,200 and I pay it once a year in April. The program lets me put aside $100 every month so when April comes, I haven’t blown the money somewhere else and find myself scrambling to come up with $1,200 (or worse, using a credit card to pay for it).

Because I can budget at that level of detail, the $100 a month has already been "mentally spent," as Spiller puts it. That constraint keeps me from overspending. People who budget "can see ahead and realize they are bumping into constraints, whereas people who are not planning go about their merry way until they’re just about to run out, and think, ‘oh if I spend this dollar now I can’t spend this tomorrow,’" Spiller told me.

Our financial lives are increasingly complicated; it’s impossible to keep future expenses in your head. And you have better things to do with your time. So here’s the secret: Find a budgeting tool that works for you, and dive into the details. My budget is broken down into more than 50 categories and the software does the tracking; I can easily move money from one category to another — choosing to spend less in one area if I decide to splurge somewhere else.

"Finer-grained categories create more constraints," says Spiller. "They also make opportunity costs jump to mind more easily because they make you think about specific purchases. If I think about a ‘dining out’ (category), future dinners come to mind more easily, and I'm more likely to realize ‘I can’t buy those dinners if I buy this.’ The broader the (categories), the less any given purchase comes to mind, and the less likely I am to think of it as an opportunity cost."

Have you found a great budgeting tool that helps you see the details, and stay on top of your spending?

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