Everyone's given some great budget ideas, so I would like to give my spin on how to make them magical. Most of my ideas are repeats of others, with a little twist.
I would definitely bring little "Tinkerbell" gifts with you and leave them for the kids to find every morning or evening. Maybe sprinkle a little confetti around, too. It's important to have that magical feel, it doesn't really matter how much it costs. You might even consider bringing some Disney stuffed animals with you to leave in the hotel room to keep the Disney feeling going. Have you considered decorating the windows with Mickey stickies or something? Maybe even bring Disney CD's for the times you'll be riding in the car? Tie curling ribbon or put a Mickey antenna topper on your car to help find it and keep up the magic. You can even buy those markers that wash off a car to write on the windows (just make sure you can still see to drive and park!)
As far as eating, I think the most important thing is to make sure everyone's full and well hydrated. If you'd like to do a grocery stop and bring some premade food with you for a picnic(there's a spot by the TTC where you can do this, I believe), or eat mostly counter service, or eat offsite (that 3.99 buffet is a great deal) that sounds like they're all great ideas. As long as you don't try to make do on too little food or water, you'll be fine. Cups of ice water are free, so if you want to ask for one instead of sodas, you'll save money. Water fountains are all around, so refill your bottles often. I'd much rather see a family picnic by the TTC than to share a small TS meal and feel hungry. Another suggestion I have is to always eat lunch at the parks unless you are staying at your hotel to swim. It wastes more money in gas to drive back from the parks, eat lunch (or dinner) and then drive back to the parks. Either bring something with you, eat counter service or eat off schedule. Gas can be expensive.
Another suggestion I have is for you to buy Disney groceries. In the Walgreens near my home, they have Disney cookies, crackers, pretzels, and candies on sale for a dollar a bag. If you bring them with you, they'll be just as good as a four dollar bag from the gift shop. At the grocery stores near me, they sell Disney cereals, fruit snacks, etc. I think it would be fun to have those things while in Disney- it would save money and still be magical, fun, Disney, etc. You could also consider bringing Kool Aid singles or iced tea to flavor the water from the water fountains.
If you stay out of the stores for the most part, you won't feel like you're missing anything by not buying a lot of souvenirs. Everyone likes the rides better anyway! If meeting characters is your priority, you don't necessarily need to do a character meal. You can just try to get to a character meet and greet before the characters get there (check the map and ask CM's) so you will be among the first to say hi. This is especially great early in the morning when many people are dashing to the rides. You will miss the "walk right on" the attractions time period, though. Another idea is to go to FW and see the campfire with Chip and Dale. I think it costs only a few dollars for a bag with sticks, chocolate, graham crackers and marshmallows. You can roast marshmallows and get in some character time. It's almost like a character meal.
Bring light sticks or light bracelets with you, too. You won't spend ten dollars a clip and you'll still glow.
Have a great time and if you miss anything, you can do it on your next trip!