Especially early in life, when you've just started working for a living, figuring out exactly how to budget your income can be tricky. In theory, all you have to do is balance what's going in with what's coming out, but, as we all know, that's much easier said than done. It's tempting to embrace simple, all-encompassing philosophies — like putting certain chunks of your income in "envelopes" devoted to certain kinds of expenses — but those tend to screw you whenever the composition of your spending changes.
So the best approach probably isn't adopting one holistic framework so much as implementing smaller, concrete suggestions to make things slightly easier around the edges. To get a sense of a few of them, I talked to writer Helaine Olen (whose book Pound Foolish is perhaps the best takedown available of personal finance hucksters) and to Harold Pollack, the Helen Ross Professor at the University of Chicago's School of Social Service Administration and author of the only index card you need to understand your finances. Pollack and Olen are working on a book of evidence-based financial advice at the moment, but they graciously shared some of their tips with Vox in the meantime.
1) Gather data
Before you actually set about creating a budget, you need to know where your money is actually going.
"Most of us do not have a budget and we don't really know what we're spending our money on. It just kind of comes in and out," Olen says. "The first thing to do is figure out where it's going, and the only way to do that is to track it for several months."
There are a few reasons for the length of that sample period. One is that you obviously can't rely on less than a month's data, given that many major expenses — rent/mortgage payments/condo fees, cable and electric bills, etc. — come in on a monthly basis. But the more important reason is that your spending will differ from month to month and getting more data will let you smooth out those fluctuations and get less noisy picture.
Luckily there's never been a better time to do this. Olen says that earlier in life she simply wrote out everything she bought on a legal pad to get a sense of her consumption habits; today, apps like Mint or Quicken or Moneydance will do that for you automatically using data from your credit cards and bank accounts, and categorize your spending as you go.
2) Don't sweat the small stuff as much
This is a point Olen made well in Pound Foolish but it bears repeating. There's a myth out there that the key to getting your budget under control is cutting back on small niceties: eating out less, taking the bus rather than Uber more, not getting that afternoon latte. But for most people, that's not the issue. The biggest part of our budgets, by far, are fixed and/or emergency costs like housing, college tuition, and health care, rather than anything smaller. Olen cites research by then-Harvard law professor Elizabeth Warren and Amelia Warren Tyagi suggesting that while only about half of peoples' incomes in 1973 went to fixed expenses, by the mid-2000s about 75 percent did.
So overspending tends to happen after some intense upward shock to spending, like a medical emergency, or downward shock to income, like being laid off. Research by sociologist Jeff Lundy into overspending found that the most common culprits behind it (especially for low-income families) are health shocks, poverty, and job loss, rather than seemingly frivolous discretionary spending. Lundy finds that people who spend more on dining out are relatively unlikely to be overspenders — people are pretty good at knowing whether they have the disposable income available to indulge. The data just isn't consistent with the view that your lattes are bankrupting you.
3) Keep an emergency fund
One obvious takeaway from the fact that overspending often results from sudden shocks is that you should be stashing away money to make sure those shocks are manageable. Keep in mind that the things you're paying for need not be absolute emergencies so much as what Pollack calls "expected unexpected expenses": your car breaking down, being locked out of your apartment and needing a locksmith, needing to hire a plumber to fix your shower.
Olen recommends you build up the fund until it's enough to sustain you for about three months. "I don't mean three months of take home pay, but three months of what you absolutely can't live without," she says. "Dinners out are not in your three month emergency fund, but your kids' college tuition is. Your mortgage payment is part of your emergency fund, but not new dishes for the kitchen."
As for where to put it, just make sure it's sufficiently liquid you can access it when the time comes. A savings or money market account is the obvious choice, though Olen notes some people come up with weird schemes where the first month's worth of savings is in a three month CD, and the the next in a two month CD, and so forth. "How you optimally store the money is a second-order issue," Pollack says. "You don't want to say you're going to set up a fund once you figure out if you want to put it into Treasuries or whatever."
4) Don't care so much about your rewards program
Pollack knows this is a controversial point, but he makes a decent argument. "Be apathetic about your credit card reward program," he says. "Don't think about free miles or cash back. The best of things are giving you 1-2 percent of what you're spending, and if you spend a little more because you're jazzed about your reward program, you've eliminated any benefits you're going to get from that."
There's some evidence bearing this point out. In 2010, the Chicago Fed's Sumit Agarwal, Sujit Chakravorti, and Anna Lunn found that customers enrolled in a 1 percent cash back credit card program spent $68 more a month on average but got only $25 back. Worse, they decreased their monthly payments, resulting in a monthly debt increase of $115. The program was particularly effective at making dormant users of credit cards start spending (and accumulating debt) again. The program, they conclude, is "a cost effective tool to increase bank revenue from increased spending and borrowing by cardholders." The real rewards go to the bank, not you.
5) Trick yourself into spending less if you need to
Again, the small stuff isn't what sinks most people. But ultimately budgeting is about, as Pollack puts it, "understanding what you actually want to spend your money on, given your various constraints and life goals." Sometimes, spending impulsively gets in the way of that goal, not catastrophically but just enough to take money away from things that actually make you happy.
If you find yourself having that problem, Olen has a whole bevy of tips for you.
"Stay out of stores," she says. "In all seriousness. I happen to love clothes quite a bit. One great budget tip is to not walk into clothing stores." If most of your shopping is online? "Don't store your credit card on any site. Trust me on this. Laziness is a very powerful deterrent for some people and the need to add your credit card info every time will reduce your spending."
But none of this is to say you shouldn't set aside money for fun. In fact, any budget you try to set will fail if it's too restrictive for you to realistically follow it. "It's like the ways we fail on overly stringent diets, because we don't match the way we actually want to be eating," Pollack says. "You don't want a 1200 calorie a day diet." And you don't want a just-business budget either.