The envelope budget method is more of an old-school but effective way of budgeting. Envelope budget systems have regained popularity in recent years, especially among social media users.
The envelope system is a simple and easy-to-use budgeting method that stopped me from overspending on specific categories, especially where I had the least control. I also like using the zero budget method and envelope system together to allocate all my money better.
Dining out used to be the worst category for me. I planned to spend $200 a month, but somehow it always ended up on a lot more than that at the end of the month. Sound familiar? So let's find out how to help you with your finances with the envelope budget method.
What Is The Envelope Budget Method?
An envelope budget method is a budgeting process in which you divide your income into different spending envelopes to control where your money is going. The original idea is based on putting physical cash into envelopes, but online alternatives already exist.
So after you receive your income, you use the cash envelope system to allocate your money into different cash envelope categories. Then, as the month goes by, you use up this budget and spend the whole allocated allowance for this spending category. Once the envelope is empty, however, you cannot spend any more money on this spending category within the current budgeting period.
The envelope budget system enforces constraints on spending. This will potentially involve not having to borrow to afford more consumption in a particular category or forgo other spending categories to fulfill this one.
It can also potentially act as an excellent saving method. The envelope-saving method allows you to allocate a certain amount of your income into the saving envelope and control your spending. If your other envelopes are set out correctly, there will be no need to take any money out of the saving envelope, and since you will be in control of your spending, it might allow you to save more.
An important thing to note is that your fixed expenses like rent or mortgage, or even a car payment are not meant to be included in this exercise since most people pay them by direct debit.
Who Is The Cash Envelope System Ideal For?
The envelope budget method is a great way to control your expenses. It forces you to stick with your planned spending. Once the envelope becomes empty, you cannot spend any more within that category.
If, on a monthly basis, you spend more than you have planned on specific spending categories or want to control exactly where your cash is being spent, you should try the envelope budget method.
The envelope budget method is excellent for you if you:
- Want to stick with your budget limits for each category
- Like paying your variable expenses in cash
- Cut unnecessary expenses
- Want a simple method that doesn't depend on apps, math, or online banking
How To Budget Your Money With The Envelope Budget Method?
When considering any budgeting method, including the envelope system, it is essential to note that no two personal budgets are the same. Specific categories and amounts in them might vary due to personal circumstances like income amount, family commitments, or debt repayments.
What is vital for success with budgeting is to create a realistic budget we can commit to. If we begin to be too strict with ourselves, we might become demotivated and give up on the idea.
Create Categories For Your Spending
The number of personal budget categories you decide to set up and what they are will be a personal choice. You want to find the right amount that will work for you, not making dividing up the process too long but also not being too vague with how it should be divided.
Aiming for somewhere between 5-9 cash envelopes will be a good number to work towards. This should cover most of the budgeters' expense categories while still accepting what they are for. A cash envelope system for beginners might include fewer categories to start without getting overwhelmed.
When I used the envelope method, I went for seven main ones: groceries, transportation, eating out, shopping, personal items, going out, and miscellaneous.
Set Limits For Each Category
Once the categories are in place, you should set the amounts you want to spend on each category. An excellent place to start this will be with your previous monthly expenses. Having this information will allow you for more realistic assumptions.
Next, you will need to set your limits based on what you can spend within a budgeting period. This period can vary if you are self-employed with inconsistent income patterns or if you are employed on the frequency of your salary.
When thinking about setting those limits, remember that our needs (expenses you can't leave without) and wants (non-essential expenses you have fun consuming) are different. Therefore, when selecting the limits in envelope system categories, you will have to base it on what you can afford rather than what you want to spend on a particular category.
It is crucial to ensure your limits are realistic and you are ready to commit to them. If you cannot stick to those limits, you might need to adjust them by adding or subtracting from different envelopes until you get comfortable with them.
Fill Your Envelopes With Cash
Once you decide on categories and their limits, using the cash envelope system is straightforward. Once the new spending cycle starts, which usually coincides with you receiving your income, you can fill your envelopes with cash. If you use a physical cash envelope method, try to avoid the ATM fees that some machines charge.
When the money is in the envelope, you will use these within the spending categories in the spending cycle. Once the envelope is empty, you won't be able to spend any more in the given category. If you have money left over, you can roll them over to the next month within the same category or put them towards savings or debt repayments.
How Do You Set Up The Envelope Budget Method?
Starting any budgeting method might feel complicated. At first, you might need to reserve some time to set it up, but once you get the hang of it, it will take you less time each month, and you will become an expert in it.
Let's look at how you can get started with the money envelope system.
1 – Calculate Your After-tax Income
The first step will be establishing how much income you will have to work with. This will be after-tax and any other deductions from your salary that are made before you receive it. This includes income tax, student loans, health insurance, and pension contributions.
If you are a freelancer, self-employed, or business owner, income might be estimated monthly. However, your monthly income might also not be the same amount; thus, you will have to account for this when planning for a longer term. Some people get paid weekly and some biweekly, so you must adjust your budget according to your situation.
A tool I find helpful is the IRS website, which is free and helps you determine how much income you can expect to receive and how much taxes you will pay. It might be worth reaching out to a tax professional for further advice.
2 – Use The Envelope Budget Template/Spreadsheet
If you are going for the traditional cash envelope system, all you will need is physical cash envelopes. You can either use a plain white envelope or use more purpose-built cash envelopes, which you can get from Amazon. You can also make some yourself.
With a virtual envelope system, you can use a spreadsheet you fill in online, for example, in Excel. I personally do use Excel very often for my budgeting needs. Learn how to make a budget in Excel. Alternatively, you can try a purpose-built app for it, like Mint and Personal Capital.
3 – Set Up Your Financial Goals
Once you control your finances with knowledge of your income and expenses, set a goal. A financial goal will give you a purpose for keeping going, ensuring you are motivated and looking with a long-term perspective. Without them, you will ask yourself – why am I even doing this?
You should have short, medium, and long-term financial goals. This will ensure you stay on track within the current month and what you are working for in the long term. Financial goals can include purchasing a house, saving for holidays, or paying down all your debt.
The exercise didn't start with setting your financial goals because you didn't know your inflows and outflows at the time. Now you can set realistic financial goals because you know your financial situation.
4 – Set Categories For Each Envelope & Fill Them With Cash
The way you will set up your categories and amount of envelopes you will need will depend on your personal circumstances. Try to aim for 5-9 envelopes.
These are the steps you want to do:
1 – Subtract all your fixed expenses and direct debit payments from your income.
2 – Make a list of all the categories where you spend your money.
3 – Use the rest of your income to set limits for each category.
4 – Put the money inside each envelope category.
5 – When the envelope is empty, you can't spend any more money on that category till you get paid and set your budget again.
5 – Evaluate And Adjust Your Spending
Constant and honest reviews of the progress you have made are critical. This can happen weekly to see how you are doing with your spending commitments or at the end of the cycle. More frequent reviews are essential for those just starting with budgeting.
Adjusting the envelope budget system is a good sign of self-awareness, and it is expected as part of any budgeting process, especially at the start. Of course, you won't get it right the first time you try, but it was an excellent first step toward success.
If you see that you are running out of money from a particular category but are left with a spare in another, then certain adjustments might need to be made. You might find hidden spending habits you weren't aware of before you started to budget.
Any adjustments that are made must be realistic, and you must be willing to stick to them going forward. There is no point in making adjustments that you will have to re-adjust next month, as this will only demotivate you. It is also critical to keep your financial goals in mind when doing so.
Try The Digital Envelope System
You can choose the digital envelope system if you don't want to carry cash around because that's not your thing or you don't feel safe or comfortable. It's precisely the same concept, but it's much easier to use daily.
You can use a budget app like Qube Money or Goodbudget to create your digital envelopes and set money to different categories. I have tried both apps, which are easy to use and secure.
With digital cash envelopes, you will stick within your budget without overspending and without the inconvenience of carrying envelopes with cash when shopping. You can also incorporate your online shopping here, making it much more manageable.
Envelope Budget System Example
The average American earns approximately $51,480 gross per year in the USA, equivalent to $4,290 gross per month. So that’s the value I will use in my example.
Note: I have researched a lot about how much the average American pays for rent, bills, groceries, etc. However, it helps to keep in mind that it varies significantly in each state. These examples are only for you to understand better how the envelope budget method works.
As you can see above, first, you calculate your income after tax ($6,151.20) and then subtract all the fixed expenses and direct debit payments to reach the total cash ($2,606.01) you can put on the envelopes. Finally, you split the money inside each envelope based on your personal needs and preferences.
Is The Envelope Budget Good For You?
Personally, I have used the envelope budget method for some time, and it allowed me to stop overspending on eating out. Once I had no money left in the eating-out category envelope, I had to wait until the next cycle to spend more in that category. It really helped me to stick to my budget while keeping my long-term financial goals in mind.
There are lots of budgeting methods out there for you to try (check the 50/30/20 or the 50/40/10). The envelope budget method is simple and easy to use, which helps people to gain control over their spending as they see exactly where they are spending their income. It also helps them to stop overspending in certain categories.
The envelope budget system will make sure that you stay in control of where your expenses are going out to. Once your envelope for that category is empty, you can no longer spend money within that category. If that sounds like something which will help you gain control over your finances – go for it!