The Ultimate Guide to Setting Up a Household Budget

No matter your income, statistics say you're probably living paycheck to paycheck. Robbing Peter to pay Paul, as it were. Little Timmy needs new cleats for soccer? Well, there goes half the electric payment.

That's how we were living for the longest time. When I started a more frugal lifestyle, one of my first steps was to sit down and create a household budget. You, too, can set up a household budget using this guide.

Set Your Goals

Before we start, let's talk about what you hope to achieve by budgeting. What is your goal?

1. Financial Security

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   This was my reason for beginning a budget. I wanted security, and not to just barely survive. Creating a budget allows you to get a good feel for what you're spending money on, what you can stop spending money on, and where you can save money you didn't know about.

2. Saving Up for a House

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   One of the more popular reasons to budget, home ownership is an integral part of the old American Dream. Being able to offer a large down payment can help keep your eventual mortgage low, and creating a budget can help get you that down payment.

3. Getting Out of Debt

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   A lot of young families shoulder the combined burden of unpaid student loans, mortgages, car payments, medical bills, and so on. Getting out of debt opens up so many doors for families.

4. Vacation Money

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   Maybe your goal isn't as lofty as buying a house. Maybe you're already debt-free or your debt is manageable. Perhaps your goal is to take your kids on the vacation they'll always remember.

5. Reducing Your Stress

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   Perhaps you're not yet clear on what you want out of budgeting, but you know you can't take the stress of your current financial situation much longer. Creating a budget, sticking to it, and watching your finances fall into place can help ease that stress and allow you to relax.

Whatever your reasoning, you've decided to start a budget. I'm here to help you do that.

Determine Your Total Income

Naturally, the first step to setting any budget is determining how much money you have in the first place. Of course, figuring out your income will depend largely on what kind of income you have.

It is important to remember some of the following formulas are for gross income — your income before taxes and other deductions are taken out.

1. Average Monthly Income

   This is fairly simple. Take your annual salary and divide it be twelve. The result will give you your monthly income. Should you need your yearly income for budgeting purposes, simply multiply the monthly by twelve.

2. Average Hourly Pay

   For this, you'll need your pay stubs. Add together the totals and divide the total by the number of work hours covered. The result is your average hourly income. It was a revelation for me when I compared what I actually earned per hour to how much a latte costs.

3. Fluctuating Income

   If you're like me, and your income varies paycheck to paycheck, a traditional outlook on your income is probably not going to work. Assuming you've been keeping track of your monthly earnings somehow, you'll want to base your budget off the lowest pay month of the previous year.

4. Reliable Overtime, Commission, or Other Non-Salary Pay

   If you work a job where overtime, commission, or some other type of non-salary pay is common enough to be relied upon, you can easily work it into your budget. Simply determine the amount of such pay you've received in the last year — it should be located on your tax information. Then add it together, divide it by twelve, and add the result to your monthly pay.

5. Taxes Taken Out

   Unless you work as a self-employed or other 1099 position, you probably have taxes taken out of your pay. If you do, great! Whichever calculations you used, be sure to add together your net pay, not your gross pay.

   If, like me, you do not have taxes taken out of your pay but want to budget as though you did, it can get a bit complicated. You'll want to use a calculator for this, unless you're much better at math than I am.

   You need to know the percentage to take out for your local state taxes, FICA, and federal taxes. Once you've deducted those, you'll have found your net pay.

Figure Out Expenses

Whew! All done with the math.

Just kidding. Now, you'll need to tabulate your monthly expenses. We're going to break these expenses down into a few categories, to start with.

Known Expenses

No, this is not the name of your kid's favorite rock band. Known expenses are the bills that are the same from month to month. These include bills such as:

• Rent/Mortgage
• Utilities
• Phone Bill
• Internet
• Cable
• Debt Payments
• Insurance

Variable Expenses

As you've probably guessed, variable expenses refer to the expenses you have each month that may vary over time. These include things such as groceries, gas, pet-related expenses, charitable spending, and entertainment.

Tracking Your Expenses

Now that you know what your expenses are, how do we fit them into figuring out a workable budget?

1. Track Your Variable Expenses

   Since the “big” expenses, such as your housing costs, are pretty much concrete, you don't need to track them. However, you'll want to track your variable expenses for at least a month.

   For something as potentially widely variable as your grocery bill, you should track the expense per week. Then add the weekly sums together at the end of the month. Use that number to help get a better idea of what you actually spend each month.

2. Track Your Excess Money

   All the bills are paid, but you're still broke and can't figure out why. For this, you'll want to do the same as you did with your variable expenses. That $1 candy bar from the gas station can add up quickly if you buy one several times a week without realizing it. It's almost always those little purchases we never think about and don't bother to track that come back to haunt us later on.

3. Track Common, Not Monthly Expenses

   Do you pay your car insurance quarterly? Annually? Do you travel? Spend money on gifts for family?

   You'll need to track all those expenses, as well, or at least account for them. Total up the amounts you've spent on any common category that isn't a monthly expense – let's say your child's annual soccer dues, holiday expenses, and maybe a semi-annual family vacation are your common expenses. Do them separately, if you pay the amount more than once a year, then divide it by twelve to get the amount you should set aside in your monthly budget to cover that expense for the next year.

Where to Cut Spending

You've tabulated your expenses. You've tracked your spending. You're probably a little shocked, somewhat irritated at your teenager's pizza habit, and a bit sheepish about that craft store clearance aisle you went a little nuts on.

You've reached the point in your budget making where you have an idea of what you need to survive, what you have extra, and what expenses you don't necessarily need. Now, we're going to look at trimming those excess expenditures to open up your funds to put in savings for that goal we made earlier.

1. Unnecessary Bills

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   Obviously, some bills can't be done away with. You need a house, so housing costs will always be there, as will utilities and so forth. There are two “big” bills that can be eliminated or traded in for cheaper options:

   • Your cell phone
   • Cable TV

   You can trade your expensive major carrier phone in for a cheaper pay-as-you-go option and save as much as $100. You can do the same with your cable plan – switch to a streaming option.

2. Extracurricular Activities

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   I don't mean cut your children's after-school activities. Every child deserves enrichment and a fun, safe environment to stretch their wings.

   There's no denying, however, that most extracurricular activities cost parents a pretty penny every year. What's a frugal parent to do?

   A few different things, it turns out:

   • Seek a scholarship or sponsorship
   • Enroll in community center activities instead of year-long
   • Register early
   • Volunteer your time — often, volunteer parents will receive discounted participation for their children

3. Surplus Purchases

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   Remember the $1 candy bar from the gas station we talked about earlier? This is the part where I tell you, “Don't do that.” At the very least, cut back on it.

   Surplus purchases are things you buy that you don't necessarily need, like books, a gym membership, a magazine subscription, or the aforementioned candy habit. Books are wonderful, but you can borrow them from the library for free. A gym membership is fantastic, but you can exercise with friends or at home, or even get your membership for free by teaching a class. And coffee made at home can be just as good as that super expensive cappuccino from the corner cafe.

   You've slashed your unnecessary expenses, eliminated your surplus purchases, and found ways to save on your children's extracurricular activities.

   But you're still broke. Now what?

4. Trimming the Necessities

   Now, you start trimming back the necessities. Of course, there are some things that will be difficult, if not impossible, to trim, such as your housing payment. That's generally fairly non-negotiable. However, there are ways to cut other costs you pay each month but can't wholly do away with. A few examples:

   • Cut your heating and cooling bill by using a programmable thermostat.
   • Reduce your electric bill by unplugging appliances not being used, such as your microwave or television.
   • Shop around for auto insurance. You may find a provider with the same or similar coverage you already have at a lower cost.

5. Reduce, Reuse, Recycle

   You've heard this slogan likely all your life – Reduce, Reuse, Recycle. It's not just good for the environment, though: it can also do wonders for your budget.

   • Reduce your grocery bill by eliminating food waste. Make a meal plan and buy only what you need for that.
   • Reuse your old things to make new ones. Turn your old clothes into new quilts, curtains, and more.
   • Literally recycle. Take your cans to a local recycling center.

Make Your Money Work for You

Now that we've freed up some money for you, we need to put that money to work for you. Part of the entire point of a budget, aside from ensuring your bills are paid each month, is to help you find potential for your “leftover” money. There are several ways this can be accomplished, and we'll go over all of them in some detail.

1. Start an Emergency Fund

   

   Pop quiz: What is your financial plan if your car needs a new transmission tomorrow?

   If you answered “I have no idea,” you are definitely not alone. Most Americans have no idea what they'd do in this situation, and simply pray it never happens to them.

   It's for that exact reason — the unforeseen— that makes having an emergency fund so important. Allocate at least $10 or more a month to this fund. Your target is to get three to six months' worth of your expenses in a safe and liquid account. That way, a car breakdown, or worse, a job loss or medical emergency won't send you spiraling into debt.

2. Create a “Cushion”

   Not to be confused with the emergency fund, your “cushion” fund is something that is important for you to have no matter what, but most especially if you have a fluctuating income. It is the fund from which you will draw during months when you don't make as much. I usually stock away at least $20 a month in this fund, more if I can swing it.

3. Begin Paying Off Debt

   This might seem counter-intuitive: spend money to save money? It's true that this won't necessarily help you save money right now, but it will get you on a more stable financial footing, open up financial doors for you, and help eliminate some of your stress. You can consolidate most, if not all, of your debt into one or two monthly bills and get them paid off at a rate you can afford.

4. Invest, Invest, Invest

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   Saving your money in the bank is not the same as investing. You may not strike it rich through investing, but building an investment portfolio will certainly help.  You have a plethora of options available:

   • Shop around the internet for an online brokerage — you may be able to find some sort of freebie.
   • Join an investment club, which is essentially a group of people who invest together. You might not be able to afford a stock on your own, but with a group of friends, you could.
   • Look for commission-free exchange-traded funds (ETFs).

5. Open a Saving Account for College

   

   As parents, we want the best for our kids. Part of that means hoping they continue on to college and degrees one day. This may seem like a rather daunting goal when you're down in debt and struggling to pay bills each month, but now that we've got you on track with your budget, you may find you have the money to spare to invest in a college savings account for your child. Open the account, and put as much in as you can. Figure out how much you think you'd be able to help with and budget a monthly deposit into the account for the amount you'll need to make that goal. Even better? Check out these age-appropriate money lessons and see which ones you can teach your kids today.

Pick Your Budget Method

Now that you've decided what you need to budget for, what you want to budget for, and how you'd like to spend your money each month, you're all set to pick a budget method. There are several of them.

1. The Envelope System

   

   Way back up there, we had you go through all your expenses. If you choose to use this system, you'll need to label individual envelopes with each of these expenses. Each paycheck, put money into these envelopes to pay the expenses they stand for.

   This was the first budgeting method I was taught, and though I've since moved on from it, I found it to be an excellent starting place. If budgeting feels overwhelming to you, I highly recommend this method as your starting point.

2. The 50/30/20 Rule

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   Using this method, you'll be allocating your finances to certain areas:

   • 50% of your budget to your needs: your house, utilities, insurance, etc.
   • 30% of your budget to your “wants”: vacation, luxury items, and those types of things.
   • 20% of your budget to your savings and debt repayments.

3. Snowball Budget

   If your goal is to get out of debt as quickly and efficiently as possible, then the Snowball Budget may be the method for you. This method is all about throwing as much of your budget as you can to your debt repayments, starting with the smallest debt first.

4. Digital Budgeting

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   Worried about keeping track of your budget the old-fashioned way? Need a little help to keep yourself on track? Try any of the budgeting apps out there; you can input your budget goals, and even receive alerts when you're reaching your spending allotment for the month.

5. Zero-Sum Budgeting

   If you're not saving up for anything, and just want to see where your money is going, this may be a great starting point for you. Essentially what you're doing here, is adding up all your income and subtracting your expenses. The goal is to have the total, once all subtracting is done, be zero.

Reiterate and Revisit Your Goals

You'll want to revisit your budget, and your goals, from time to time. As life changes and time goes on, you may find you've met your goals, or that your income has changed and you need to readjust your budget. Should you find yourself with a drastic change in income, you may want to redo all the steps above to ensure your budget works for your new financial status.

If you meet your goal, you may wish to make a new one to keep yourself on track. Sometimes, having a goal is the best way to keep yourself motivated.

Whatever your goal, creating and sticking to a budget can help you and your family in the long run. I hope by the time you've set your goals, gone through your expenses, and found the method that works for you, that you find the peace of mind I found. Did you enjoy our household budget guide? Let us know what you think in the comments below, and share this article if you enjoyed it with your friends and family.