One of the oldest and most reliable ways to budget and manage your money is the envelope system.
Not only is it a great way to stay on track with your budget, but it can actually simplify your entire financial situation.
I’d even go as far as saying that it can change your entire financial future.
But what is the envelope system? And why does it work so well?
That’s exactly what we’re going to discuss.
Let’s dive in!
What Is The Envelope System?
The envelope system is a cash-based budgeting strategy wherein you divide your income into envelopes designated for a specific purpose. Throughout the month, any money that you need to spend is taken from the envelope that corresponds with that expense’s category.
For example, if you place $500 in your grocery envelope, you can only spend that money on groceries.
Additionally, you have to find a way to make each envelope last the entire month. Because when the money runs out, you can’t pull money from other envelopes.
For this reason, we recommend pairing the envelope system with a zero-based budget and tracking all of your expenses throughout the month.
That way, you can easily track your progress for every envelope throughout the month, and make sure you don’t overspend.
Why Does The Envelope System Work?
Part of the reason that most people struggle with money is that they don’t have a plan or a system.
Their paycheck goes into the bank account when they get paid and they swipe their debit card (or their credit card) every time they need something.
This lack of control can lead to overspending or running out of money before their next paycheck.
Meanwhile, since the envelope system is cash-based, you won’t be able to overspend.
The envelope system has several keys benefits:
- Easy to Use – The envelope system is perfect for people who are new to budgeting. More complex systems can be overwhelming to learn. By keeping it simple, people are more likely to follow through with budgeting.
- Cash Only – When you stick to cash, it’s impossible to spend money that you don’t have. Since the traditional envelope system relies on cash, you have no choice but to stop spending and reevaluate your budget if you run out in a certain category.
- More Emotional – For some people, swiping a debit or credit card doesn’t really feel like spending money. This is a dangerous mindset that can lead to serious financial consequences. When you use cash, there’s more of an emotional connection that has been proven to help you control spending.
Want more budgeting and money-saving tips and tricks? If so, you’ll love these:
- 5 Urgent Things To Do If You Have No Savings
- Zero-Based Budgeting: What Is It? And How To Do It?
- 7 Budgeting Tips For Singles [Save Money And Enjoy Life!]
- Budgeting For Couples: 10 Tips To Ease The Tension!
- Living On A College Budget: 21 Tips That Won’t Wreck Your Fun!
- 25 Ways To Save Money On Groceries [And Eat Well]
- 7 Ways To Get Better At Saving Money
- Axos High-Yield Savings Review [Our #1 Pick For 2021]
Pros And Cons Of The Envelope System
Every budgeter is different.
Some tools and resources work better than others, so it’s important to thoroughly understand and evaluate your options.
Envelope System Pros
- Avoid Overdraft Fees – Since you are using cash, you don’t have to worry about accidentally incurring overdraft fees for spending money you don’t have in the bank.
- Better Visibility – With your money being separated into different categories, you can quickly see how much you have left for groceries, car expenses, or entertainment.
- Easier to Coordinate with Others – If you have a spouse or significant other, successful budgeting is all about clarity and communication. The envelope system makes this easy. At any point, either one of you can quickly check your “balance” in a certain category. For example, if you want to go to the movies with a friend, you can easily see if there is enough money left for entertainment.
Envelope System Cons
- Security – Having large amounts of cash lying around can leave you at risk of theft. You can mitigate this a bit by storing your envelopes in a safe or lockbox.
- Frequent Trips to the Bank or ATM – The great thing about modern technology is that many things like direct deposit and recurring payments for bills are automated. With the envelope system, you are going to be doing things manually which means more trips to the bank or ATM.
- Cash is Not Accepted Everywhere -You should be fine using cash for most expenses, but there are situations where cash isn’t accepted. You’ll have to figure out how to pay for these items. Some people simply deposit the money into their bank account and pay with a debit card.
How To Create An Envelope System
Creating an envelope system is really simple.
First, you need to create a zero-based budget.
To do this, calculate what you expect your take-home pay to be for the month.
Then, subtract the amount of money you plan to give and save/invest.
After that, make a list of all of your major expenses and how much you would like to budget for each item.
Using historical numbers from your checking account can help you calculate approximately how much money you spend on things like groceries, dining out, and entertainment.
Once you have your budget, get some envelopes and label them.
You have lots of options when setting up your envelopes.
Some people like to have a ton of envelopes, while others like to keep it simple and have one envelope for the entire category. For example, if you are setting up envelopes for utilities you can separate them (water, electric, gas, sewer, trash, etc.) or keep them together (utilities).
It’s entirely up to you to decide what works best for you and your situation.
Pro Tip: Using different color envelopes, stickers, or images on the corner can keep you organized and help you find what you are looking for quickly.
Finally, you need to fund your envelopes.
Ideally, you will have a month’s worth of cash available.
If this isn’t possible, you can simply split up the money each time you get paid. If you get paid twice a month and your grocery budget is $400, you can put $200 into your grocery envelope each time you get paid.
What To Do With Leftover Money
It’s very likely that you will have money left over in some of your envelopes.
When this occurs, I highly recommend adding it to your savings or investing it.
You can also have a little fun with your envelope budget and use the leftover money to fund a “prize” for underspending your budget.
For instance, you could put all your leftover envelope money toward a vacation savings fund, a new car fund, or even a new set of golf clubs fund.
Best Practices When Using The Envelope System
As with any budgeting method, the key to the envelope system is to stick to the limits that you have set for each category.
You must fight the urge to raid other envelopes if you run short in another.
A good idea is to have a plan in place for when this happens (and it WILL happen from time to time).
For example, if your car repair budget has $100 in it and your transmission dies, you’re going to need to get the money elsewhere. In this case, sit down and decide how to proceed.
You could cut your restaurant budget in half, eliminate your entertainment fund for the month, or, as a worst case scenario, you could even pull money from your emergency fund.
Additionally, it’s important to always pay yourself first. You also want to make sure that you have a dedicated saving or investing envelope. By consistently funding this envelope, you will make steady progress toward your financial goals.
Bottom Line
You’re going to make mistakes, so try not to sweat the small stuff.
If you accidentally underestimate the cost of an expense, make the adjustment the following month.
Ultimately, the key to success with the envelope system is to stick with it and try to improve a little bit every month.
While it might be hard at first, over time, your financial life will transform into a well-oiled machine.
Now go get some envelopes, hit the ATM, and get to it!
