The budgeting process is not complicated. Once you're determined to draw up a budget for your household, a few steps are all it takes:
1: Know your financial goals. You'll have long-term goals like creating a nest egg for retirement, intermediate goals such as amassing a down payment on a home, and short-term objectives like paying your monthly bills.
2: Get a clear idea of your income. Look at the after-tax money that you bring home in every pay check. Add back whatever's deducted for your 401(k) retirement plan, medical insurance or union dues -- you'll include those amounts in your budget. If your income varies considerably, take an average of what you've earned over the past six months or year. From that, calculate your average monthly income.
3: Track your past spending. You'll want to look at your credit card bills and debit card statements, your checking account records, and any payments you make through electronic banking. You'll also include amounts for retirement accounts, insurance or dues that are deducted from your pay. To account for cash spending, you and other family members should keep a spending log. Note every penny you spend, whether it's on a cup of coffee, a new pair of shoes or a jumbo popcorn at the movies [source: Peterson].
4: Categorize your spending. Group your expenses into buckets such as housing (including rent, mortgage, home maintenance, utilities), transportation (including gas, car payments, auto insurance), entertainment, food, clothes and savings. Make sure you include home owner's insurance or local taxes, which you pay only once or twice a year. Don't forget what you spend on credit card interest and bank fees, as well.
5: Make a spending plan. Based on your past spending and your financial goals, decide how much money to allocate to each category for the month. This is an extremely personal decision. You should be realistic and clear about your spending plans.
Author and Harvard Law professor Elizabeth Warren suggested a simple budgeting approach in her book "All Your Worth," which she wrote with her daughter Amelia Warren Tyagi. The appeal of her approach is that it's both simple and flexible. It sets a goal of spending no more than half your pay on necessities and of devoting one dollar in five to savings or debt reduction. She calls it the 50/30/20 plan, and breaks down spending into three distinct categories [source: Warren]:
- Must-Haves. Fifty percent of spending goes toward basic expenses like housing, utilities, transportation and basic phone service -- things you can't do without. Keeping your Must-Haves down to 50 percent, Warren writes, makes it easier to adapt if one member of your household loses a job or you're hit with unexpected expense.
- Wants. Another 30 percent should be budgeted for things you would like to have but that you can easily delay buying, such as clothing, dining out or a new smartphone.
- Savings. The final 20 percent of your spending goes into savings or debt repayment.
There are plenty of other systems for setting spending goals, too. For example, CNBC columnist Carmen Wong Ulrich advises spending 30 percent of income on housing, 18 percent on transportation, 10 percent on debt reduction, 14 percent for food, 7 percent for utilities, 10 percent for savings and 11 percent for everything else, from clothing to charity donations [source: Ulrich].
For a lot of people, creating a budget isn't the problem -- it's sticking to it that's tough. We'll discuss ways you can stay within your budget and even reduce household expenses in the next section.