How to Use the Envelope Budgeting System

I’ve written in the past about how I used to have such a hard time budgeting. I know I’m not the only one out there who has felt that budgeting is frustrating, tedious, and sometimes downright depressing. That improved once I got a good budgeting system in place and stuck with it.

I’ve shared one of my favorite methods in the past, the 50/20/30 system. Today I want to discuss another method I really like, the envelope budgeting system.

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How does it work?

This method is exactly as it sounds. You use physical envelopes for each category of your budget. You fill each envelope with the cash allotted to that category each month.

Then you spend the cash from that envelope for its given purpose until it’s gone. No more than that, and actually, hopefully less than that.

This is considered a traditional method of budgeting. Think of your grandparents.

I know that my grandparents, who lived through the Great Depression, never owned a credit card in their lives. They paid for everything in cash. Their belief was that if you don’t have the money, then you don’t buy it.

You may have heard older people talk like this too. So it’s safe to say that this method or some variation of it has been around a long time. It’s worked for folks in the past and can work for you too.

Why does it work?

When you use cold hard cash, the money is there or it isn’t. If you have $100 in the grocery envelope and you spend $50 on one trip, you know you have $50 left. When the $100 is up, then you know you don’t have anything left to spend.

When you use electronic budgeting, it’s easy to get caught up in switching numbers around between various categories. It’s not so easy when the cash is in hand.

In fact, the authors of the book Happy Money cited research stating that people feel the pain of separation from cash more than from a credit card.

That’s why it’s recommended to use cash when you want to be more careful with your spending, and one reason why credit card companies love for you to use cards.

Does this mean you have to starve?

No, not exactly. The first key to using this budget is to allocate adequate funds to each category. If you know that you have to feed a family of four people, it’s very likely that $100 will last for a month. If you’re trying to cut back from $500, try starting with $400 in the envelope.

Give yourself a reasonable amount to start. You can adjust the amount in grocery envelope next month when you have a better idea of your spending.

Also, any good budgeting system allows for flexibility. If you have $100 in the entertainment envelope and you’ve spent all your grocery money, you can take $50 from your entertainment for the month and move it to the groceries envelope.

This should only be done if you really need to do it. You need to eat, but you don’t need entertainment.

I know not everyone will agree with me on this, but I believe that the best budgets are flexible enough to work with you and your ability to change rather than making you feel deprived and want to quit budgeting altogether.

How many envelopes do you need?

This depends on your situation. There are literally hundreds of categories big and small that you can list on envelopes.

I personally don’t want the hassle of a hundred envelopes. So while you can make an envelope for every category in your budget (meaning all the cash you have), it’s probably easier to pick a limit your categories to as many as you can handle. That could be just a few categories where you need them most help or 10+ categories.

For me, I would pick three to five between eating out, entertainment, groceries, clothes and shoe shopping, and beauty products. Notice that except for groceries, these tend to be considered luxuries and have variable costs each month.

I don’t need an envelope for categories with fixed amounts each month (e.g., rent or cell phone) because those don’t change. You may find it helpful, however, to have an envelope for those as well. It’s up to you how many categories you’d like to address.

What do you do with leftover money?

There are a couple of options for what to do with leftover money at the end of the month.

Roll it over into next month’s envelope for that category
Put the extra money towards another category next month
Spend it on something you like, want, or need
Bank it or invest it

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How do I start?

1) Take out cash from the bank or ATM.

Some people may cash their whole paycheck and divide all the money between envelopes. If you are doing this for only a few categories, calculate how much you'll need in cash. If you need $300 for three envelopes next month, take out that much and not more.

2) Get some envelopes.

If you don’t have any envelopes on hand, use ones that come in the mail. I recycle the contents of the envelopes and keep any return envelopes that were inside.

3) Write your category names on the envelopes.

4) Write down the amount of cash that is in an envelope at the start of the month. Then subtract anything you spend to keep track of what you have left.

5) (Optional) Keep your receipts to look them over for miscalculations or reflection at the end of the month.

Here’s a visual of a simple distribution:

Your envelopes may look something like this:

Who is this method for?

This method is good for anyone who wants to get their finances in order. Anyone can use it to varying degrees.

It may be good for the person who wants to get one or two categories under control or a family who wants to account for all expenses.

Generally speaking this method is likely to be easier for people with more simple financial situations such as a young single person versus a family with multiple people spending money from the same categories.

A single family may find it easier to use that someone who runs a company dealing with invoices and paying workers. It wouldn’t be a smart move in the last case.

Are there any drawbacks to this system?

Every method has its pros and cons and this one does too. The main drawback I find is that cash is not protected like credit cards are.

If you lose an envelope, the money is gone. The same is true if you walk around with a wad of cash in your pocket and the money falls out or gets stolen.

If you lose your credit card, you can call the credit card company to cancel it and get a new one without any monetary loss. You can also earn points or rewards when you use a credit card.

That’s why I’d recommend storing the envelopes in a safe place. Keep them safe at home and only take out the envelopes that you’ll need to spend when out of the house that day.

You can also start with small budget categories so you don’t have hundreds or thousands of dollars in cash lying around the house.

Another drawback is lack of convenience. How often do you pay your cell phone bill in cash nowadays? That would involve taking time to go to your carrier’s store versus a minute or two to pay your bill online.

You also wouldn’t be able to take advantage of automatic bill payment, which can be a lifesaver if you’re forgetful with paying your bills on time.

But if the envelope method gets you on the right track with your money management, then the benefits may outweigh the drawbacks.

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