Takeaways
- The envelope system is a cash-based approach to budgeting.
- The traditional form of envelope budgeting involves stuffing cash in envelopes.
- The envelope system increases the pain of the transaction and makes you physically allocate your hard-earned income
- The modern approach allows you to use mobile applications or spreadsheets.
- You can closely track your expenses and have a hard cut-off point on spending when you run out of cash in a category.
What is a Budgeting?
A budget is your financial plan, based on your income and expenses, that helps you decide where to allocate your money. Your budget considers all your sources of income and expenses throughout the month, acting as a financial roadmap. A budget provides guardrails to help you achieve your financial goals.
Budgeting can help you navigate your monthly expenses like paying for essential expenses, paying off debt, buying large-ticket items (e.g., buying a house), and meeting long-term savings goals. A budget is your personal business plan. There are many budgeting strategies, each with its philosophy about how to prioritize your money. One method that has worked for millions of people is the envelop budgeting method.
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What is the Envelope Budgeting Method?
The envelope budgeting system has been used for decades and came to life in the 1980s and 1990s. This budgeting method advocates physically pulling out your after-tax income in cash and allocating your money into envelopes.
Overall, the process is optimized for simplicity. Once you have your after-tax cash, you take an envelope and write an associated expense on that envelope (e.g., rent). Then stuff the necessary cash to pay for that expense in the corresponding envelope. The key to the envelope system is that once an envelope is empty you cannot spend any more money on that expense.
Practically speaking, most people using the envelope system budget monthly because of the physical nature of dealing with cash and envelopes. Sitting around the kitchen table to stuff money into an envelope takes some time, but envelope budgeting system aficionados swear by this ritual.
How the Envelope System Works
The first step of the envelope system is to withdraw your paycheck from your bank account. If you have a high income, you will probably need to speak to a bank teller to make your withdrawal.
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Once you have your pile of cash safely back home, you can start thinking about all your expenses and group them into categories. The envelope system provides flexibility to determine your spending categories and does not assign specific percentages to spending like a 50/20/30 budgeting system. You can borrow suggestions on percentage spending from other budgeting systems and integrate them into your envelope system.
We suggest thinking about spending categories in terms of fixed and variable costs. Fixed costs are those that do not change with your level of consumption, like your rent. Variable costs, on the other hand, fluctuate with how much you consume, such as going out to eat or buying new clothes.
Fixed Costs:
- Mortgage
- Rent
- Car Note
- Student Loan
Variable Costs:
- Going out
- Transportation
- Food/Restaurants
- Drinks
- Utilities
The next step is to label each envelope with an expense. For example, one envelope might be “Drinks with Friends.” The next might be “Vacation Savings.” The next might be “Rent” and so on. Once your cash is fully stuffed into all your envelopes, you are complete with this step and can move on to spending your money.
The catch is that you can only use funds from that envelope for the designated expense. After your “Drinks with Friends,” envelope is exhausted, no more going out. If you have remaining cash in an envelope at the end of the month, you have a few options:
- Put the remaining dollars into savings.
- Transfer funds to an alternative envelope.
- Roll over the money to next month’s envelope.
Advantages of the Envelope System?
Provides Financial Discipline: The envelope system is formulated on the idea that if you use cash to make purchases, you will consume less. If you decide to follow the cash envelope budgeting system, it will usher discipline into your financial life.
Inserts Guardrails: With the allocation of cash to specific expense envelopes, the system will keep you on track. Although you might need to titrate how much to allocate to each expense category, your envelopes act as financial guardrails.
Forces Accountability: Personal and household accountability is critical for any budgeting system to work. The envelope budgeting system is difficult to implement because it requires planning, foresight, and diligence. This thrusts financial accountability into your life and might be the jumpstart you need to get your spending under control or save even more.
Curbs Overspending: There is no better way to curb spending than to run out of cash for an expense category. No more cash in your “Restaurants” envelope? Then no more eating out until you get a cash infusion with your paycheck. Strictly speaking, the cash envelope system shies away from credit cards (cons discussed below).
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Problems with the Envelope System
Passing up Credit Card Benefits: Paying all your expenses with cash will make you miss out on countless credit card benefits, like travel points or cash-back rewards. Because your fixed costs are often your highest, one solution is to pay your high fixed costs with your credit card and automate your finances to pay off these expenses. Then apply the envelope system to your variable costs.
Complexity for Households: The envelope method can compound complexity if you are managing a budget with your spouse and have children. Using the envelope system with a household takes constant communication. That communication may revolve around who is responsible for physically paying certain expenses and where specific envelopes, such as the grocery store envelope, are stored.
Carrying Large Amounts of Cash: The envelope method is purposefully abrasive. There are plenty of modern ways to use technology to seamlessly pay your bills with credit cards or Apple Pay, which only requires a few plastic cards or your phone. With the envelope method, you must carry a wad of dollar bills (watch your back). One solution is to only hold a certain amount of cash, say $200, a day. This will control your rate of spending and ensure you are not carrying too much money.
Practicality of Implementing: The hurdle for entry into the envelope system is high. Going to the bank, getting cash out, and dividing your income into many marked envelopes takes time and effort. Another way to implement the envelope budgeting system is to inject a bit of modern technology into the process using spreadsheets or apps. With diligence, you can accomplish your goal of tracking and spending your expenses.
Other Budgeting Methods
If the envelope budgeting system does not work for your finances, that is totally fine. There are many other highly effective and less cash-demanding methods of budgeting strategies that work for millions of households. Below are some of our favorite budgeting systems:
- Passion Budgeting
- 50/20/30 Budgeting
- Pay Yourself First Budgeting
- Paycheck Budgeting
- Zero-Based Budgeting
The envelope budgeting system can be quite demanding because it involves a lot of upfront work. The system forces you to confront how much you spend each month and starts the process with a massive pile of cash. This monthly exercise of withdrawing cash and not accruing the benefits of cashless payments with credit cards can sometimes be too much if you are trying to take advantage of technology and automate your finances.
For those who love the envelope system, it gives them a sense of immediate control. Let’s be honest, this budgeting system might be a perfect fit to get you off the ground and to help you understand your cash flow. After you have your spending allocations solidified, you might want to consider a more modern method of budgeting. You want to find a budgeting strategy that works for you.
What is the Best Budgeting Method?
There is no one perfect budgeting method. The goal is to find a budgeting system that works for you. If you have a spouse and family pick something that works for the group. Finding the right budgeting strategy might take some time and exploration.
Smart Summary
Budgeting is one of the keys to financial success. Less than a third of American households create a budget, and as a result, they don’t hit their financial goals. You can implement different budgets to keep your spending on track and reach your saving and investing goals. The cash envelop system is a great budgeting system that forces accountability. Becoming disciplined enough to stick to a budget is a smart money move.
