Finding the right budgeting system to help you manage your money is a valuable step toward financial wellness, and one system to consider is the envelope budgeting system. This is a very tangible, physical system in which you divide up a month’s worth of cash to be spent into good old-fashioned envelopes, organized by category.
This method can be a great way to literally get in touch with your money and see how it’s spent.
Key Points
• The envelope budgeting method uses cash to manage spending by dividing money into envelopes labeled by category, such as entertainment or groceries.
• This method controls discretionary spending by making it tangible and limiting purchases to the cash available in each envelope.
• Spending is halted in a category once the cash in its envelope is depleted, promoting financial discipline.
• Intentional spending is encouraged, helping to reduce overspending by increasing awareness of financial habits.
• This practical system aids in better financial management and avoiding debt by adhering to a budget but can be difficult for those who don’t usually pay with cash.
What Is the Envelope Budgeting Method?
There are many different budgeting methods to choose among. The envelope method for budgeting money (also sometimes called the envelope saving method) 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.
You determine your spending categories, such as entertainment, food, and so forth. You label an envelope for each, and then you divide your monthly available money from your checking account into the appropriate categories.
Then, as the month goes by and bills come in, you pay with the funds allocated in each envelope. Here’s one of the key points for envelope method budgeting: When the money is gone, it’s gone. The idea is to not dip in elsewhere to come up with cash for, say, a pricey sushi dinner you indulged in on impulse. The point is to get used to sticking to your budget.
Next, you’ll learn the steps to setting up an envelope budget.
How Does the Envelope Method of Budgeting Work?
Here’s a look at how the envelope method of budgeting 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 (whether that means moving money into a savings account for an emergency fund or the down payment on a house) into 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? Grab a latte almost daily? 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 amounts that are lower in the categories where you can.
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3. Withdrawing Cash and Putting it into Envelopes
The next step in an envelope method budget is to 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 at 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. Make change if you use an ATM that only spits out $20s. With exact amounts, you’ll avoid the extra work of 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
Then, for the month ahead, the envelope method budget means that when you need to buy something, you take money from the appropriate envelope. You may not want to carry the envelope around with you, which could mean spending more than 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. Some tips to help this process:
• 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.
• If you choose to purchase something online, 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 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.
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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 time for a full stop.
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.
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If you deplete your entertainment budget, look for ways to save money on streaming services. Try 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.
Pros of the Envelope Budgeting Method
Here are some of the most important benefits of the envelope budgeting system:
• It makes spending tangible. Buying things with plastic can make it feel as if you haven’t spent any money at all. When you pay with cash, you’re forced to consider your spending and may spend less.
• This system helps realize just how much you are spending on various expenses. For instance, you may not have realized how much you spend on take-out lunches until you see that $20 bill leave your hands every weekday.
• This budgeting technique also makes it all but impossible to overspend, since you have a hard and fast budget limited by the cash in your envelopes.
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Cons of the Envelope Budgeting Method
Yes, there are good reasons to try this budget system. However, it’s worthwhile to know some disadvantages before you dive in:
• Carrying cash to pay for your daily expenses as part of this system can be risky; you might lose the money or, in rare cases, be robbed.
• The cash-centric nature of the envelope budget can be difficult for people who do a lot of online banking and online transactions, like to use a debit card, and/or patronize shops that are cashless.
• If you like to use plastic and get cash-back rewards or other perks, you will not be able to accrue those benefits while following the envelope budgeting method.
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The Takeaway
The envelope budgeting system is one method that can guide you on your financial journey. By putting cash into envelopes marked for specific purposes, you can gain insight into where your money goes and hopefully rein in areas where you can cut back.
Another way to take control of your money is to find the right banking partner.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
FAQ
What is the downside of the envelope budgeting system?
Some downsides of the envelope budgeting system is using cash to make payments. This can be inconvenient for people who prefer to use debit cards or online payments.
What is a budget system that involves envelopes?
The envelope budgeting method is a budget system that involves putting cash for different spending categories into separate envelopes. The cash is then used to pay your expenses; when you use up a month’s cash, that’s it. You don’t spend any more on that category.
How much money do you save with envelope budgeting?
How much money you save with envelope budgeting will vary, as it will with any budgeting system. For instance, if you discover that you use up more money than you allocated for dining out, you might decide to reduce your spending in that area from $120 a month to $70 a month and save $50 in that time period.
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