The Envelope System: The Effortless Way to Budget
Creating—and sticking to—a budget is one of the cornerstones of personal finance. But if you’re struggling to find a budgeting system that works for you, you’re not alone.
Maybe you’ve already tried tracking your expenses in Mint or created a complicated, headache-inducing Excel spreadsheet. Those tools work great for some, but if you keep falling off the budgeting bandwagon you’ll be surprised to learn that one of your best weapons in the fight against overspending could be the simple, lowly envelope.
What is the Envelope System?
The Envelope System is a budgeting method where you withdraw a set amount of cash each month for your discretionary spending in various categories (Groceries, Dining, Clothes, Entertainment, etc.) and place it in labeled envelopes.
All of your spending throughout the month for those categories is done using that cash—no credit or debit cards allowed! Once an envelope is empty, you stop spending for the month.
Making the Envelope System work for you
When it comes to budgeting methods, it doesn’t get much easier than the Envelope System. Though it’s been popularized in recent years by personal finance guru Dave Ramsey, this technique has actually been helping folks stick to a budget for decades.
And it’s easy to see why. Unlike some other methods, the Envelope System includes built-in repercussions for overspending (no more cash for the rest of the month!) and rewards for spending under your budget (leftover cash!). This comes in handy when you're struggling to stay motivated.
1. Calculate your discretionary income
Discretionary income is what’s left over after your fixed expenses, such as rent, utilities, insurance, phone service, and debt payments, have been covered.
Tip: Try to reduce your fixed expenses before starting the Envelope System. If you’re paying for premium cable channels you rarely watch or a cell phone plan that’s way too expensive, now’s the time to make changes (and put some of that money back in your pocket).
2. Set your budget.
Decide on a budget for each of your spending categories, making sure that the total does not exceed your total discretionary income. If you need help determining how much money to put in each category, check out some of these simple financial rules of thumb. You can also set it up as monthly budget or a biweekly one, depending on how often you’re paid.
Common discretionary spending categories are below, but everyone’s list looks a little different. Maybe you’ll want to combine Dining and Entertainment into one envelope, or add an envelope for Gifts. That’s fine, as long as you spend only what’s in your envelopes.
- Household Goods
Some categories, such as groceries and gas, aren’t exactly optional. But you do have some discretion when it comes to how much you spend in each category—by purchasing store brand products, carpooling to work, etc.
Recommended Reading: How To Make A Budget That Works: The TMPF Guide
3. Create envelopes.
This one is self-explanatory. If having snazzy, decorated envelopes makes you more likely to stick with the program—then go crazy! They even sell cash budgeting envelope and wallet systems on Amazon.
Or, you can do what I did--just use plain old letter-sized envelopes with the category name written on the front.
Tip: Color-code your envelopes in some way so you can tell at a glance which one to grab money from when you’re rushing out the door.
4. Stick with it.
The Envelope System is simple, but it all falls apart if you’re not consistent. Use cash every time.
For the first few months, you’ll be working out the kinks. Which envelope do you use for your yoga classes? How do you keep your change separate when spending in multiple categories?
As long as you’re consistent (and using only the cash in your envelopes!) you can set your own rules.
Tip: Remove your credit card and debit cards from your wallet entirely, if it helps you avoid the temptation to overspend.
5. Save or pay down debt with leftover money.
Hopefully you won’t spend every last dollar every single month. So what to do with what’s left over? If you have debt, your first priority should be to pay that down. And if you’re debt-free, try investing with a robo advisor that has no minimums and low fees.
One of my favorite things about envelope budgeting is that it makes spending tangible in a way that using credit cards just can’t. Need to know if you can afford to order takeout? It’s as easy as peeking inside your “Dining” envelope. You’re reminded of the impact of your spending every time you grab an envelope and see what’s left.
Avoid potential pitfalls
Always remember that the cash in your envelope is a spending limit, not a spending requirement. There’s nothing saying that you have to spend it all each month, so don’t buy something you don’t really want or need, just because you still have some cash left at the end of the month.
The Envelope System works best when you have already set aside a resiliency fund for unforeseen expenses like new tires, burst pipes, or a trip to the emergency vet. Having at least $1,000 set aside can prevent this kind of expense from turning into a huge budgeting roadblock.
What if you’re trying to budget with a spouse or other family members? While that does make things a bit trickier, it’s totally doable. You just need to agree on the ground rules, and communicate, communicate, communicate.
Some families choose to divide budget per person, with the person who does the bulk of the spending in a certain category getting allotted the most money each month. Others do fine with everyone working from the same envelope. Again, the trick is the find what works for you, and stick with it.
If circumstances conspire to throw your monthly budget into a tailspin, you’ll need to decide together how to address it. Will you dip into your resiliency fund? Or borrow money from another envelope? Better yet, your partner might have some ideas on ways to address the need cheaply. After all, two heads are better than one.
If you hate the thought of adding ATM visits to your list of errands, try to make it a little less painful with some preplanning.
For example, does your grocery store have an ATM that you can withdraw from with no fees? Or could you combine your ATM visit with your weekly fill-up at the gas station?
So, which envelope should you pull from when you go to Target and buy food, clothes, and a new book? Depending on which categories you use, that one transaction could hit on three different envelopes (Groceries, Clothing, and Entertainment).
When possible, I pull the cash from whichever category I expect to represent the bulk of my spending and then move money between envelopes as needed as soon as I get home. Just find a process that works for you and make sure you do it consistently.
If you’ve had success—or struggles—with the Envelope System, please share in the comments below!