When you’re creating a budget for yourself, it can be helpful to put up some guardrails to help keep you on track. With the envelope budgeting method, those guardrails are physical, allowing you to spend only a set amount of cash on certain categories throughout the month.
This method makes spending money more tangible since you actually have to watch the cash leave your hands, and once the money in one category is gone, you have to stop spending.
How the Envelope Method of Budgeting Works
There are many methods to help you build a budget. The envelope method for budgeting money is a system that helps you track your spending by limiting it to cash transactions. In this way, an otherwise fairly abstract concept—your spending—is turned into something you must literally hold in your hands. Here’s a look at how it works.
1. Determining Your Discretionary Income
The envelope method usually works best when you use it to budget for discretionary spending. Your discretionary spending is the money you spend on things you may not really need, such as entertainment.
To determine your discretionary income, take your monthly income and subtract any necessary expenses, including things like housing costs, utilities, and insurance payments.
You may want to include debt payments and savings goals in this category as well. Anything you have left over is your discretionary income.
Budgeting rules of thumb, such as the 50/30/20 rule, can help you determine your discretionary spending as well.
2. Deciding on Budget Categories
Once you have a total for your discretionary income, you can begin to break it down by category. The spending categories you choose will depend on your own habits. You may want to pay special attention to areas where you already have trouble with overspending. Eat out too much?
Consider this an opportunity to put a cap on that spending. Other common areas to consider include groceries, entertainment, clothing, and gas money. You may want to build in a catch-all category that gives you some money to use for fun as well.
Assign a dollar amount to each category. Consider reviewing past bank statements to help you figure out what you normally spend.
Your bank or credit card may even break out your spending into categories for you, making it easy to tell where you typically spend. If you’re trying to cut back, assign dollar amount that are lower in the categories where you can.
3. Withdrawing Cash and Putting it into Envelopes
Get one envelope for each category. Write the name of the category on the envelope and the dollar amount you have assigned to it. At the beginning of the month, withdraw enough cash to fill each envelope.
Depending on your situation it may work better for you to spread your withdrawals out to align with your paycheck. If this is the case, you could take half the money out in the beginning of the month and the remaining half when you receive your next paycheck.
When you go to the bank, get the exact denominations that you need. For example, if you assigned $55 to your entertainment budget, make sure you get exactly $55 dollars. That way, you don’t have to do any extra work remembering where you need to shuffle dollars around.
If having a pile of envelopes feels too disorganized, consider using a coupon organizer. These look like little divided wallets or small accordion files. The idea here is the same as with the envelopes, and you should label each section with the category and dollar amount.
4. Spending Only Cash
When you need to buy something, take money from the appropriate envelope. You may not want to carry the envelope around with you, risking spending more that you need to, or risking losing it. If you only bring $50 to the grocery store make sure that your total doesn’t go beyond $50.
Try to avoid the temptation to spend with your credit card too. It might help to remove your credit card out of your wallet while you use the envelope method. If you choose to do this, consider storing the card in a secure place where you can access it when you absolutely need it.
5. Once Your Cash Is Gone…it’s Gone
Here’s where the real discipline comes in with the envelope method. Once you’ve used up the cash in a given envelope, it’s gone.
This means no more spending in that specific category for the rest of the month. Remember, you’re trying to control your spending, so avoid borrowing from other categories.
If you deplete your entertainment budget, try to find free alternatives like watching movies at home. If you run out of money for groceries, get creative with leftovers and try to use up whatever food you have left in your cupboards and fridge. These exercises should hopefully help you begin to spend more and more intentionally as time goes on.
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The Advantages of the Envelope Method
One of the main pros when using the envelope method is that it makes spending tangible. How you pay for things can have a big effect on how much you’re willing to spend. According to a 2018 report published by Valuepenguin, consumers are willing to spend more money when using their credit cards.
Afterall, they don’t see the money leave their bank account. But, when spending cash they are forced to consider their spending and may spend less.
Sticking with the envelope method also makes it all but impossible to overspend, since you have a hard and fast budget limited by the cash in your envelopes.
So, when using this method you can most likely avoid worrying about issues like overdrawing your bank account or running up high credit card bills with your discretionary spending.
The envelope method can also force discipline into your budget. To maintain your budget you must think carefully about your spending, which may change your long-term spending habits.
Left with Extra Cash?
At the end of the month you may find that you have extra money in some of your envelopes. Depending on your budget and goals, you have a few options for how to use the remaining money.
One option is to roll the money over into the next month. Say you had $500 for groceries but only spent $450. You can take the extra $50 and put it toward your next month’s envelope, so your new budget would be $550.
Another alternative is to put that unspent cash toward a financial goal, such as paying off student loans or saving for a wedding.
What About Online Spending?
When using the envelope method, it can be easier to track your spending if you’re paying for most things in cash. But in the 21st century, online shopping can be unavoidable.
If you choose to purchase something on the internet, such as concert tickets, for example, note the purchase on your envelope immediately. You can then remove the cash you spent online from the envelope.
When using credit cards, pay off the balance by the due date to avoid accruing interest. In that case, the amount you actually pay for the item will be more than the amount you took from your cash budget, throwing your budget off.
When buying things online, continue to keep in mind the dollar amount you set for that category. Try your best to avoid overspending, based on the limits you set for each envelope at the beginning of the month.
Budgeting with a Partner
The envelope method does not have to be a solo endeavor. It can also work if you have a partner. The key is communication and deciding on the system that works best for the both of you. Try working together to set a joint budget, determining spending categories and cash amounts together.
Then work out how you will divide the money each month. Find a balance that works for you both. For some couples, that could mean a 50/50 split. In some cases, one person might do all the spending in a certain category, so they’ll hold that envelope by themselves.
Setting a regular check in with each other could be one way to make sure you are both on track for the month’s spending. These check-ins can be a time to address anything that isn’t running smoothly.
Consider tweaking how much cash each partner is carrying, making necessary changes to the spending categories, and adjusting cash amounts as necessary.
Planning for an Emergency
Life can always throw you a curveball. If it does, you may end up needing to reshuffle the cash in your envelopes to help cover unexpected expenses. Look for categories that are easy to forgo, like clothing or eating out and dip into these before touching more necessary expenses like gas or groceries.
To help avoid a situation like this, consider building an emergency fund. Start by making it a regular savings goal. Another option is allocating any unspent envelope money to the emergency fund at the end of the month.
A robust emergency fund can help you ensure that you don’t torpedo your budget should your transmission fail or you encounter an unexpected medical bill.
Even More Envelope Budgeting Tips
Here’s a look at other tips and tricks that could help you succeed if you choose to budget using the envelope method:
Creating sub-envelopes: Within certain categories, you can create sub-envelopes to help you be sure you don’t run out of cash at the beginning of the month. For example, you might divide your monthly eating out budget into four. That way you can be sure you can eat out at least once a week for the entire month, and you won’t be tempted to blow your entire budget on eating out for five days straight.
Leveraging lists: When you go shopping, consider planning ahead and making a list of what you need. With a list in hand, you can estimate costs before you even get to the store. Once there you can keep track of the cost of each item so you know whether you will come in on budget.
Reevaluating regularly: Your budget isn’t static. As you use the envelope method over a number of months, you may notice your spending change in certain categories. If you find that you no longer need the full amount you’ve been allocating to certain expenses, you can adjust it. You can shift excess cash to other categories, or bank it in the form of savings, debt repayment, or a financial goal of your choosing.
You may also discover as you continue, that you need to add new categories or that you can remove some entirely. As you get started using the envelope system, you will likely need to make adjustments until you find a system that works for you.
Using online tools: One of the nice things about the envelope methods is that it makes spending in your target categories extremely easy to keep track of. But that doesn’t mean that you shouldn’t keep your eye on your bigger financial picture, as well.
All budgets require discipline and sometimes a certain level of discomfort as you’re forced to make compromises. Yet the important thing is that you stick to it. Doing so gives you the opportunity to change your spending habits and to make financial moves that will help you accomplish your goals.
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