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How to Create a Household Budget That's Right for You

Take these steps to spend less, save more and achieve your financial goals

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For some people, the only thing less fun than doing taxes is creating a budget. But a good budget means that you can do many of the things you want to do, such as taking a vacation or buying a new car, without worrying about where the rent money will come from. And if you're realistic, a good budget can be remarkably easy to create and maintain.

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A budget is a way to figure out where your money comes from, where it goes, and how to end up with money left over at the end of month. That's the bottom line: Spend less than you make and save the difference for specific goals of your choosing. Basically, budgeting consists of four steps:

Step 1. List your income

For most people, that's take-home pay. You can't avoid paying taxes or health insurance. If you have other sources of income, such as Social Security or IRA distributions, add those in, too.

Step 2. List your fixed expenses

These are the expenses that have dire consequences if you don't have enough money to pay them: rent/mortgage, utilities, insurance, car loans, credit cards, medicine.

Step 3. See what you have left

If you don't have anything left, you need to reassess your income and expenses and perhaps even take drastic measures, such as selling your car, moving to a cheaper place or seeking a better-paying job.

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Step 4. List your flexible spending

This is the money that goes to ordering takeout and delivery, traveling, streaming music and movies, shopping online for a new wardrobe and so on.

Be warned this is not always as simple as it sounds. “While it's relatively easy to get information on rent or house payments, car payments, utilities, and insurance, it's harder to track variable expenses, such as food and gasoline, and even harder to track purely discretionary expenses, such as dining out, new furniture, clothing and charitable contributions,” says Mark Bass, a financial planner with Pennington Bass & Associates in Lubbock, Texas.

Use budgeting tools

One solution is to jot down these expenses, should you happen to have paper, pen and a place to write every time you spend money. A more practical way would be to use various budgeting apps, such as Mint, a free budget planner and credit monitoring tool. Honeydue is a free app for budgeting with your partner. Nerdwallet has a free app that will help you track your spending, your credit score and your net worth. And you can always use the online budgeting tool from AARP

If you track your spending, you'll get a good idea of where your money is going, and how you can save more of it. For many people, the budget busters are generally small things that add up over time, says Ray Ferrara, a financial planner for Provise Management Group in Clearwater, Florida. “Most people fail to account for the ‘creepers,'” Ferrara says. Those are the things that creep into our spending habits. “We go to the grocery store and buy things that are not on the list. We can't say no to the grandkids’ latest toy/video game. All of these are spur-of-the-moment decisions that, in and of themselves, do not seem to bust the budget, but when added up over the course of the year have the potential to do so."

A budget is something you can't just write down and forget: If you want to make good use of it, you have to track it and see where you go off course. “For the most part, people spend more than they anticipate,” says Jeffrey Corliss, a financial adviser in Westport, Connecticut. In a way, it's like piloting a boat, he says: “You can make changes before you end up in the ocean."

One way to make things easier is to automate your saving, rather than writing a check every month. There's not a financial institution in the world that wouldn't be glad to tap your bank account at regular intervals. Set up an automated savings plan with a bank, brokerage or mutual fund company and don't alter it, if you can.

Putting it together

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The idea behind a budget is to have savings, and the idea behind savings is to have money when you need or want to spend it. It's useful to think of having several buckets of saved money. (Some people call them envelopes, after the old-fashioned system of putting cash into various envelopes marked for different spending needs.)

You should have at least two savings buckets for money that's available when you need it: one for emergencies, and another for retirement. You can divide emergencies into two sub-buckets, if you like. A smaller one — $1,000 or so — is for the inevitable car repair, dishwasher replacement or emergency vet visit. If you keep this in good shape, you won't have to charge these expenses.

The other emergency fund is for a major expense, which generally means a fund for paying the bills if you lose your job. Most financial planners recommend a fund equal to three to six months’ worth of expenses. This is a terrifying amount to many people, but remember: It's for your fixed expenses, not your entire paycheck. If you have $3,000 in monthly take-home pay and $2,000 in fixed expenses, then you'll need $6,0000 to $12,000 in your emergency fund. This is still somewhat terrifying, but it's a goal: Set aside a certain amount toward it each month.

How much to save for retirement depends on how old you are, how much you have already saved and what other resources you may have, such as Social Security or a pension. You can use the AARP retirement calculator to help you figure out how much you'll need for retirement. But again: The idea is to start saving, or increase saving, from the money you've saved by creating a budget.

The final savings category is the best one: money to make your life better. This could be for a new car or a home renovation. The sky — and your budgeting prowess — is the limit. Working for a living and not spending on things you enjoy can make life a drudgery. Creating a workable budget means you can not only remove the worry of running out of money, but you can spend it in a way that brings you happiness.

John Waggoner covers all things financial for AARP, from budgeting and taxes to retirement planning and Social Security. Previously he was a reporter for Kiplinger's Personal Finance and USA Today and has written books on investing and the 2008 financial crisis. Waggoner's USA Today investing column ran in dozens of newspapers for 25 years.

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