Only one third of Americans use a detailed budget to manage their monthly finances. Just under two-thirds of Americans can’t handle a $500 emergency, essentially living paycheck-to-paycheck. If you don’t budget and/or are living paycheck-to-paycheck, don’t fret. Improving your situation is easier than you think - especially with the right resources.

We’re not perfect budgeters, but we definitely have a detailed monthly plan and are more than covered for a $500 emergency. In today’s post you’re going to get the nitty gritty details of exactly how we budget for our single-income family of five.

At the highest level, monthly budgeting is a fairly simple concept:

  • Compute how much you’re going to earn
  • Estimate everything you need to spend in the next month
  • Make sure that you’re spending less than you earn :)

When my wife and I first started working on our finances together, this is about as complex as our budget was. Over the last number of years, we’ve learned a ton and have developed a system that really works well for us.

The benefits of budgeting on our end have been clear:

  • We rarely have an expense we need to pay that we can’t cover
  • Our stress about our financial situation has gone dramatically down
  • We’re doing a better job putting our money where are hearts are - spending on things that are true priorities
  • We’re kicking butt at paying off our debt and staying on track in our savings goals

The net effect of budgeting is not just a better financial situation but also a better marriage (Tweet this )

Our system has helped us communicate better about our financial goals and make sure we are on the same page.

The rest of this post will be the step-by-step method to apply our system from scratch. At the end of the post, I’ll have a cheat sheet that summarizes the major points for easy reference.

Step 1: Align On Goals

When it comes to budgeting, the most critical part isn’t numbers - it’s setting goals so you can build a budget to achieve them (Tweet this )

Every December, my wife and I have a discussion about what our goals are for the next year and the long-term as well. We talk about our desire for travel, our goals on debt freedom and financial independence, what charitable giving we want to be able to do, any increase we feel we need in our emergency savings, and any projects we’d like to set money aside for.

We try to pick some specific targets for how much we think each goal will cost and estimate when we’d like to accomplish each one.

We write the whole list down in priority order and hold on to it until we’re ready to set up our expected monthly budget for the next year.

Step 2: Minimize the Complexity

One of the things that can make budgeting intimidating is that monthly income and spending can be hard to estimate.

For expenses, some things come weekly, some monthly, some once a year, and some just when you least expect them.

Income is a bit easier but it still isn’t consistent month-to-month if you’re a part of the 69% of American workers that are paid bi-weekly or weekly.

If you’re paid bi-weekly, you have 10 months a year where you only get two paychecks and 2 months a year where you get three.

If you’re paid weekly, you have 8 months a year where you only get four paychecks and 4 months a year where you get five.

I don’t know about you, but the thought of trying to adjust my budget every single month just because of how many paycheck Fridays fall in sounds like a pain.

The key to simplifying monthly budgets really comes down to figuring out how to smooth out your income and expenses so things become more predictable.

Smoothing out Income

If you’re in the majority and are paid bi-weekly or weekly, there’s a simple trick to smooth out your income.

I call it planning for a ‘reasonable minimum income’ and it looks something like this (Tweet this ) :

  • If you get paid bi-weekly, pretend you only get two paychecks a month for the whole year (even those months where you get three)
  • If you get paid weekly, pretend you only get four paychecks a month for the whole year (even those months where you get five)

You can apply a similar mentality if your pay is variable (hourly, includes tips, etc):

  • Look at your pay stubs and find the worst paycheck you had that wasn’t due to some crazy, abnormal circumstances - make this your reasonable minimum paycheck

The goal here is to set yourself up comfortably in a way that your necessary expenses are more than covered in a reasonable month.

Later on, we’ll talk about what to do when there’s extra money beyond this minimum reasonable amount.

Smoothing out Expenses

Expenses occur at lots of different cycles, and this can be really difficult to manage.

Our solution is to group them together by frequency and then apply the same method to handle each group.

We’ll call each group a “branch” and we break our expenses into four branches: the paycheck cycle branch, the monthly expense branch, the long cycle branch, and the targeted goals branch.

Grab a piece of paper (or a spreadsheet) and divide it into four parts. Fill out your expected expenses in each branch without worrying about the total:

  • Paycheck Cycle Branch: Expenses here include things like groceries, gas, household goods (toilet paper and the like). How much do you spend on each from one paycheck to the next?
  • Monthly Cycle Branch: These include our predictable monthly expenses - such as our mortgage payment, charity, kids activities, and utilities
  • Long Cycle Branch: Include any expenses that happen on a regular cycle that’s longer than a month. Property taxes, car insurance, and quarterly water utility bills are good examples.
  • Targeted Goal Branch: This includes any big financial goals you have for the year. Think back to the priorities you set in the “Aligning Goals” section. This is where you put your money where your mouth is.

Here’s an example that we’ll carry through the rest of this post:

Example budget with expenses in each category

Step 3: Normalize To Get a Monthly Picture

Here’s where everything starts to come together. We’re going to template out what a “standard” month now looks like, taking all of your expenses into account.

First, add up all of your paycheck cycle expenses. Write this number down in the paycheck cycle box. Multiply that by the number of minimum paychecks you’ll get in a month (2 if you’re paid bi-weekly, 4 if you’re paid weekly) and write the number down as well.

Second, add up all of your monthly cycle expenses and write the number in the monthly cycle box.

Long cycle expenses take a bit more work to get smoothed out.

We’re going to use a cool concept called Personal Escrow to make your planning a whole lot easier (Tweet this )

Personal Escrow

Just about anyone with a mortgage is familiar with the concept of escrow. A mortgage company needs you to pay your property taxes and homeowners insurance. If you don’t, their stake in the house is at risk.

As a result, most mortgages come with an expectation of escrow from the lender. With this, your check to the lender doesn’t just go toward paying the loan, they also set aside some to pay your property tax bill and your insurance.

When it comes time to pay the big property tax bill, the money is already sitting in an account they own and your lender can write the check for you. Saving for this expense is about as effortless as it can get.

We’re going to apply the same concept but on a personal basis. Instead of having your lender hold on to the money, you’re going to set up a savings account dedicated for your own Personal Escrow to cover your long cycle expenses.

Side note: Often, you can talk a lender into letting you handle escrow for property taxes and homeowner’s insurance on your own. That way, you can get the interest on that money sitting in an account all year instead of your lender.

Take each of your long cycle expenses and figure out how much you would have to save up each month in order to pay for it.

As an example, if you have a $4800 annual property tax bill, you’d need to save $400 each month to get there.

If you have a $180 quarterly water and sewer bill, you’d need to save $60 each month to cover it.

Add all of these monthly amounts together and you’ve now determined your monthly Personal Escrow amount for long cycle expenses.

Example budget monthly totals computed

Step 4: Check Where You Stand, Recalibrate

At this point, you’re ready to see where you stand. We’re intentionally holding off on targeted goals and the reason will become apparent soon.

Add up your monthly totals for paycheck cycle, monthly cycle, and long cycle (AKA your Personal Escrow amount).

Compare this to your monthly reasonable minimum income that you figured out in the Smoothing Out Income section.

If your monthly reasonable minimum income is less than your total monthly expenses, it’s time to go back and reassess. You’ve got a budget that’s out of balance and you’re going to have to make some cuts. Revisit your expenses in each category and see what you can reduce. Then go back through the math until your monthly reasonable minimum income is bigger.

Total expenses compared to toal income

Once your monthly reasonable minimum income is bigger, you can start to figure in your targeted goals. Any remainder in a given month can be applied to those. The great part here is that we’ll build this into the monthly budget.

If you’re not happy with how much is going to your targeted goals, revisit the other areas and see where you can make adjustments.

Step 5: Write Down Your Budget

Now, you’re going to actually template out what each month will look like.

One of the most powerful concepts we use is assigning expenses to individual paychecks (Tweet this )

Here’s an example of how this works:

  • Paycheck 1: $2,000
    • Paycheck Cycle: $600
    • Charity: $500
    • Personal Escrow: $560
    • Utilities: $190
    • Targeted Goals: $150
  • Paycheck 2: $2,000
    • Paycheck Cycle: $600
    • Mortgage: $1,000
    • Hobbies: $240
    • Targeted Goals: $160

By assigning expenses to each paycheck, we shorten the cycle to as small as is reasonably possible (one paycheck), minimizing the likelihood that you overspend in one category at the expense of another.

An important note here is that we budget ahead for all expenses in all four branches.

We have money in an account to cover anything we purchase before we go ahead and buy it. No charging something on the credit card and relying on the next paycheck to cover it.

You’ll see that each paycheck has a line item for targeted goals that gets us up to our total paycheck amount. This means that every dollar from each paycheck is accounted for.

The beauty of applying things this way is that you are making measurable steps (even if they are small ones) toward your big financial goals every single month.

Step 6: Set Up Your Accounts

We use Capital One 360 for our checking and savings accounts. One of my favorite things about Capital One 360 is that the accounts are free and it’s super easy to create additional savings accounts.

As you’re about to see, we take full advantage of the savings account features of a Capital One 360 account.

We have one checking account and 11 savings accounts which we use to manage our finances.

Sound complex? It really isn’t.

We have a dedicated account for Personal Escrow, as well as one account for each of our targeted goals:

  • Emergency Savings
  • Charity
  • Vacation
  • Remodeling
  • Oldest Child Savings (funded by us)
  • Oldest Child Savings (funded by her)
  • Twin 1 Savings (funded by us)
  • Twin 1 Savings (funded by her)
  • Twin 2 Savings (funded by us)
  • Twin 2 Savings (funded by her)

Each paycheck gets deposited into our checking account and we pay our monthly expenses straight out of there.

Any time an expense comes up that’s from our long cycle list, we transfer money from our Personal Escrow account into our checking account and pay from there.

Whenever we’re ready to use money from one of our targeted goals, we transfer the money from that account into checking and pay from there.

Sensing a theme? Our checking account is where all the daily action happens and the other accounts are holding spots for money for specific purposes.

And by the way, those savings accounts actually get a bit of interest too.

We’ve been using Capital One 360 for 12 years and have been really happy with the ease-of-use and the respectable interest rate in savings accounts.

If you sign up for an account using this link, you can get a $25 bonus.

Step 7: Go Through Your First Month

Now that everything is set up, let’s walk through how the first month would go.

  • Paycheck 1: $2,000
    • Paycheck Cycle: $600
    • Charity: $500
    • Personal Escrow: $560
    • Utilities: $190
    • Targeted Goals: $150

When paycheck 1 gets deposited in our checking account, we immediately do the following:

  • Transfer $150 to the account for targeted goal that’s at the top of our priority list
  • Transfer $560 to our Personal Escrow account
  • Write a check for $200 to our church
  • Write a check for $200 to The Hope Effect
  • Transfer $100 into our charity account (the remainder of our charity amount)

The remaining expenses ($600 for paycheck cycle, $190 for utilities) get paid out of our checking account as they come up.

Two weeks pass and paycheck 2 comes.

  • Paycheck 2: $2,000
    • Paycheck Cycle: $600
    • Mortgage: $1,000
    • Hobbies: $240
    • Targeted Goals: $160

On the day that paycheck gets into our checking account we:

  • Transfer $160 to the account for targeted goal that’s at the top of our priority list

The remaining expenses ($600 for paycheck cycle, $1000 for mortgage, $240 for hobbies) get paid out of our checking account as they come up in the next two weeks.

Our mortgage payment auto-transfers on the first of the month. Our gymnastics fees auto-transfer as well.

It takes some work to get to the point of having this system set up, but once you do, all you have to do is follow the template for each paycheck each month and you can be confident you’re making progress in the right direction.

By breaking everything into bite-size chunks, sticking to the budget becomes a part of your weekly rhythm instead of a once-a-month coin toss.

Bonus Round

Remember how we set up the monthly budget to be a “reasonable minimum”?

For those of you who are paid bi-weekly, you now get a twice-a-year present of an extra paycheck. If you’re paid weekly, you get this four times a year!

Based on the way we budgeted, that paycheck only needs to cover paycheck cycle expenses. The remainder ($1400 in our example above) can be immediately applied to your targeted goals when this magical paycheck comes.

Alternately, these extra paychecks may be needed to provide some margin for your first year in case you missed anything in your expense estimates.

We apply the same mentality to any unplanned income - tax refunds, bonuses, etc.

They can all go straight toward the highest priority targeted goal

By having that mentality set up ahead of time, you’ll avoid the temptation to blow that extra income on something that really doesn’t match with your priorities.

That’s why step 1 is so important.

By identifying goals first, extra money has a predefined home instead of getting blown on impulses. (Tweet this )

Extra Credit

The one final recommendation I’d have in your budgeting is to track your spending.

I can’t emphasize this enough. Track your spending people! (Tweet this )

As much work as you’ll do in putting together a budget, the reality is that your spending estimates are going to be wrong in some way.

The only way to improve your estimates is to actually measure what you spend and use that information in the next version of your budget.

Our family uses the tool I created (Thrifty) to track our income, taxes, and expenses. It’s free and works on your computer, phone, or tablet.

You can categorize your spending and also track your income and taxes so you get a complete picture of your finances.

Thrifty is a manual tracking tool - you have to manually enter each expense. I prefer this method because I think there’s a deterrent effect.

I’m much less likely to go buy that unnecessary cup of coffee from the cafe when I can make one at home if I know I’m going to have to log it into the tool.

For automated options, you can check out Personal Capital or Mint. Both are free and connect to your bank accounts to monitor and classify your spending.

Once you’ve got a good handle on what you’re actually spending, you can fine-tune your budget and figure out how to keep moving it in a direction that better reflects your values and goals.

10-point Cheat Sheet

Whew, that was exhausting, right?

Since you got through the full version but probably weren’t taking notes, here’s a cheat sheet version of the 4-Branch Budget that you can use as a reference:

  1. Identify your financial goals and write them down in priority order
  2. List out your expenses on each of the major branches:
    • Paycheck Cycle
    • Monthly Cycle
    • Long Cycle
    • Targeted Goals
  3. Normalize these for monthly spending using the concept of personal escrow
  4. See what your total is (excluding targeted goals) when compared to your reasonable minimum income; go back to 1, 2, and 3 as necessary until your income exceeds your expected expenses
  5. Write down a standard monthly budget, remembering to assign expense categories to each paycheck
  6. Set up a checking account, a Personal Escrow savings account, and one savings account for each targeted goal - We use Capital One 360
  7. As each paycheck comes in, transfer and spend according to the expenses you assigned to that paycheck
  8. When long cycle expenses come up, transfer the money from Personal Escrow and breathe easy. For spending on your targeted goals, just transfer from the relevant savings account
  9. Use any unplanned income (extra paychecks, tax refunds, etc) to go straight toward your targeted goals
  10. Track your spending in detail and use that information to evolve your budget to be more accurate. I recommend you use Thrifty, Personal Capital, or Mint.

Using this system has been incredibly effective for our family and has made managing our finances much less stressful.

It’s been an 8-year journey to get to this point, so hopefully having this all in one place can get you there a whole lot faster!

If you’re looking for other good budgeting resources, here are a few you could check out:

How do you budget? Was anything from the 4-Branch Budget new to you?