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Envelope Budgeting System – How It Works, Pros & Cons

By Casey Slide

envelope budgeting systemSo you’ve been working to make a budget using tools like Excel or Mint.com and have been diligently putting in all of your income and expenses. Yet every month, it’s the same result: you continue to overspend.

While your efforts to create and maintain a budget are commendable, there is probably nothing that is actually holding you accountable to that budget. There is no reward if you succeed, nor repercussions if you don’t.

So how can you make your budget actually work for you, and how can you hold yourself accountable to it? Try the envelope budgeting system.

Envelope Budgeting System – How It Works

The envelope budgeting system is very tangible. You use cold hard cash to control your spending and when you run out, you stop spending. Here is the process for how it works:

1. Determine Your Discretionary Income
Before you start the envelope system, determine how much you have available after you pay your bills and put money aside for savings and investments.

2. Decide on a Budget
Once you know how much money you have left, decide how to divide it among the different budget categories in which your monthly spending varies. Some examples of common categories include: groceries, household items, entertainment or dining out, clothing, gifts, gas,  and allowance (to be spent as fun money).

Tip: Look back at your bank statements to get an idea of how much you have been spending in these areas.

3. Create Envelopes and Stuff Them with Cash
Get an envelope for each category and write the category name on the front. Then, after each paycheck, put in the budgeted amount of cash.

4. Spend Cash Only
Once you run out of cash in an envelope, you have met your budget for that pay period and are unable to spend any more in that category until the next pay period.

5. Pay Off Debt with Extra Money or Save It
If you have any debt, use the money left over from your envelopes to pay it off. If you do not have any debt, put your extra cash into savings.

Advantages

  1. It Works! The best part about the envelope budgeting system is that it simply works. If you are only paying for things using cash, and you run out of cash, you cannot possibly overspend. The envelope system has been around for a long time for good reason.
  2. It Will Help Discipline You. We all need discipline in our lives to make us better people, whether it is with our spending habits, our eating habits, or our productivity at work. The more you practice being disciplined, the easier it is to take responsibility for other life areas you want to improve.
  3. It Can Be Used as an Emergency Fund. Instead of carrying cash, many people carry plastic, which can be a problem if an emergency arises. Though the money in the envelope system is not intended for emergencies, you can always use it for one – like if your car breaks down in the middle of nowhere and you need to pay for a tow or a ride back home.
  4. Your Budget Becomes Tangible. The concept of money is much more tangible if you use cash instead of plastic. Credit cards can easily cause you to overspend. When using envelope cash, you will be more in tune with your budget because you’ll be reminded of it every time you reach for an envelope to spend from.
  5. No Overdraft Charges. Have you ever been charged an overdraft fee from your bank? If you put away your debit card and use cash instead, you are much less likely to overdraft and get charged the absurd fee.
  6. Less Wasteful Spending. When I used an Excel spreadsheet to create my budget, I would look back at the end of the month and be surprised to see what I wasted my money on. However, when you use the envelope budgeting system, you are more likely to think through every purchase. You’re less likely to spend wastefully when you see the money disappearing before your very eyes. In fact, people spend 10% to 15% less when using cash.
  7. You Won’t Miss a Payment. When using the envelope budgeting system, you pay upfront and there is nothing you need to keep track of. On the other hand, if you use an electronic program to do your budget, it is easy to miss entering in purchases. I believe the budget I kept electronically was off by hundreds of dollars each month due to the fact that I lost receipts on a regular basis.

money envelope

Disadvantages

  1. It’s Tough to Get the Whole Family on Board. Some people are adamantly against using cash. They like the simplicity and ease of using plastic, and who can blame them? However, for the envelope budgeting system to be successful, the whole family needs to be fully committed to making it work. Otherwise, it won’t.
  2. You Must Go to the Bank or ATM to Withdraw Cash. I really try to avoid going to the bank or the ATM. It is just another errand I have to run in my already busy life as a stay at home mom. But if you use the envelope budgeting system, you’ll obviously have to get cash from somewhere to stuff your envelopes.
  3. Getting Started Can Be Confusing. I know that the process I described sounds pretty straight forward, but you will eventually come across situations that can be confusing. For example, if you make a purchase at Target and buy $20 worth of groceries, $20 worth of clothing, and $20 worth of house decor, where do you get the cash from? You will probably need to get it from three different envelopes. You’ll experience a learning curve as you figure out how to stick to your categories.
  4. You Won’t Get Credit Card Rewards. Before I used the envelope budgeting system, I would rack in enough points to earn $250 a year with the best cash back credit cards. But with the envelope budgeting system, you forego credit card rewards because you won’t be using your credit card as much or even at all.

More Tips for the Envelope Budgeting System

1. Pick Categories You Have the Most Trouble With
My husband and I used to have an envelope for clothing. But after about six months of never using any cash from that envelope, we decided it was wasteful to budget money to that category. Instead, we put more money towards household goods, and if we ever decide to buy new clothes, it can come out of that category. There is no need for an envelope category that you do not overspend in.

2. Use a Small Accordion Folder Instead of Envelopes
A good friend of mine made this suggestion. She recommends it because instead of having seven different envelopes to keep track of, she only has one. Her accordion folder is envelope size, so it is perfect for keeping cash. It is also more durable than paper envelopes.

3. Only Take the Cash You Need
If you have budgeted $100 for eating out this month and go to a work lunch, don’t bring all $100. Instead, just take what you need from the envelope at home and put it in your wallet for the day. This is especially helpful when you have multiple people using the same main envelopes.

4. Budget by Paycheck
There are several different ways you can set up your budget: by week, by month, by quarter, and by paycheck. I recommend doing it by paycheck because you can accurately plan your budget according to the timing of your paycheck and bills.

5. Adjust Your System as Necessary
It may take a while to get everything set up correctly. You may go through a dozen pay periods before you get your budgeting amounts and categories just right. Definitely make adjustments. Nothing is set  in stone until you decide you are comfortable with the program.

6. Reduce Your Bills
By reducing your bills, you significantly increase your discretionary income. Consider strategies like finding a cheaper cell phone plan or getting rid of cable TV. Reducing your bills provides more cash for your envelopes.

7. Decide the Rules Beforehand
One issue my husband and I debated was whether or not to borrow from other categories if we ran out of cash in one of them. This is up to each person or family who uses the system. However, I recommend determining the ground rules before starting to avoid possible confusion. Through trial and error, we eventually decided to combine categories that we commonly borrowed from. Remember, it’s fine to adjust as necessary.

8. Use Extra Money to Pay Down Debt
If you do have extra money at the end of your budgeting cycle, use it to pay off debt. If you are debt free, I recommend either investing that money or saving it. I save extra money for the purchase of a van since it is an upcoming expense that we want to pay cash for.

9. Stick with It
It takes time to get disciplined, and it will take time to get the correct amounts budgeted for your envelopes. Have some patience because if you do, the envelope budgeting system will not fail you.

Final Word

In the electronic era in which we live, it might seem archaic to carry around paper envelopes of cash. However, don’t think of it as being behind the times. What’s most important is that it works. As long as you stick to the rules and put away the plastic, it will work. After all, if you are out of cash and don’t use plastic, you can’t overspend.

If you do want to utilize more technology, check out Mvelopes, an award-winning online spending management tool that’s based on the traditional envelope method of budgeting.

mvelopes

Have you ever used the envelope budgeting system? How did it work for you?

(photo credit: Shutterstock)

Casey Slide
Casey Slide lives with her husband and baby in Atlanta, GA. She graduated from the University of Florida in 2005 with a bachelor’s degree in Industrial Engineering and worked for a prominent hospital in Atlanta. With the birth of Casey’s son in February 2010, she decided to become a stay-at-home mom. Casey’s interests include reading, running, living green, and saving money.

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  • http://madsaver.com Mac

    Hmmm…you actually put cash in each of these envelopes to be used for each category? I can’t see myself doing this. Instead, I’m trying to use YNAB 3 (You Need A Budget) to limit spending on each of these categories. I tend to use a credit card almost exclusively, but ensure that I never carry a balance to offset any of the negatives.

    • Mike

      After 30 yrs of budgeting and the last 15 using computer programs I can tell you that if you carry your cards around you will overspend.. The envelope system has worked for me so well that I no longer have any budgetIng software just a spreadsheet that I track my monthly underrun on..

  • http://gomelrun.blogspot.com Melyssa

    The envelope system works for me. Ever since I heard about from Dave Ramsey, I was hooked. It just made sense to me. I use it for everything from planning a trip, to saving for our property taxes to misc money. I often find that we end up saving money because the utility bill was not as high this month, or groceries were light this week, etc.

    The only money I keep in the bank are savings and 2wks of gas money for my hubby. He does not like using cash to pay for gas, so he uses the debit card. Hey, it was a compromise.

    • Erik Folgate

      yeah, the envelope system especially works if you’re on a really tight budget. We’ve scaled it down a little bit to only have cash in an envelope for expenses that tend to fluctuate more like entertainment, food/eating out and household expenses. I like using the debit card for gas too, although, there’s a new scam going on where people can grab your debit card number from gas pumps, so watch out for that!

      • http://gomelrun.blogspot.com Melyssa

        I do feel that using cash helps lower my chances of identity theft. I had been a victim once. But darn those scammers at the gas stations.

        Yes, we are on a super tight budget. Besides the mortgage, our only debt is a $13000 slide-in camper loan. The loan is for 15yrs, but I plan to pay it off in a year by squeezing the budget.

  • Jeff

    My wife and I tried the envelope system for three months. We hated it. What I ended up doing was creating additional checking accounts at my bank and used those accounts as the “envelopes.” Each account has its own debit card. I get paid monthly and set it up with my employer to have a set amount transferred to each account (i.e. the “envelopes”). We have one of the “envelope” accounts established for groceries, to which I’ve assigned $300/month. My wife is very careful to never exceed the budgeted amount of $300. In fact, we usually have a surplus. This use of separate accounts as “envelopes” is much preferred in our household!

    • http://moneymamba.com JT

      This is what I do, too. Checking accounts are easy to set up, and you don’t have to have a ton of cash laying around the house.

  • NYC

    I thought I invented the envelope system! When I lived and worked in Spain in 1974, I was paid on the 20th of the month, but my rent was due on the 1st. Each month I allocated money for rent, food, transportation, shopping and fun. When I got to the 16th, I often found I had a surplus, so I would go on a spending binge. Then I would get paid again, settle down for a few weeks, and repeat the cycle. The envelope system worked for me.

  • Guest

    I love the envelope system! I use a software program (Snowmint Budget) rather than actual envelopes. Less onerous that way, but the benefits you detail remain the same — for me anyway.

    Envelope budgeting works for me like other budgeting tools never did. I recommend it either as the old-fashioned use of actual envelopes or with the technology of software.

  • Guest

    I love the envelope system! I use a software program (Snowmint Budget) rather than actual envelopes. Less onerous that way, but the benefits you detail remain the same — for me anyway.

    Envelope budgeting works for me like other budgeting tools never did. I recommend it either as the old-fashioned use of actual envelopes or with the technology of software.

    • Casey Slide

      I’ll have to check Snowmint Budget out. Thanks for sharing!

  • Beyerl M

    I need some help here. I don’t know what I did wrong, but something isn’t adding up somewhere! I have been doing the envelope system since January 1st and have loved it thus far. The problem is, I somehow have extra cash (about $50). I have all of my receipts and have totaled out each category; each envelope has the same amount of cash as I have listed on my record (from totaling up the receipts). What am I missing? Why do I have extra cash? I can’t figure it out. Thanks for any help!

    • Casey Slide

      At least you have extra cash instead of missing cash! Is the cash tied to a particular envelope? Where is the extra cash?

      • Beyerl M

        This may be where something went wrong: I was using the bigger bills from one envelope instead of smaller bills from the envelope that applied to the purchase. However, I kept track of the purchase with the receipts and my tally inside the envelope. I replenished the first one from the smaller bills, like I’d never used them.

        So, for example, say I had a purchase in necessities for $45 but wanted to break the $100 in my clothing envelope. I would use the $100 bill but mark on the necessities tally that I spent $45, deduct it from my remaining funds, and make sure the remaining cash matched that amount. Then I would replenish the clothing envelope so that there was still $100 in it. Does that make sense? Am I missing a step somehow? I am definitely glad that it’s extra cash instead of missing cash! I don’t know where exactly it came from, but I think little bits came from several envelopes.

        And thanks for your quick response! :)

        • Casey Slide

          It sounds to me like you are doing it right. I would continue what you are doing and see if you continue to come up with extra money. It may have been a one-time miscalculation.

  • Anita

    I’m setting up to switch over to the envelope system. The question I have is how to handle bills that I pay online – how does that work with this system. Also I have certain food items, supplements and clothing, etc. I pay for online to get deep savings. So if I have my $100 a month grocery money in an envelope how do I make a purchase of $25 online with my Co-op (food). Hope this makes sense. Help anyone?
    Anita

  • Melanie

    Great article… There are some good iPhone apps out there now too for envelope budgeting. I’ve been using iEnvelopes, which looks to have a similar budgetting philosophy. For us it has been a great way to keep my money separated without using physical envelopes. Trick is to keep it simple as suggested here.

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