When you are trying to get your personal finances in order and achieve your financial goals, finding a budgeting method that works for you is one of the most important steps. You need a method that makes sense to you, works with your lifestyle, and that helps you stick to the budget you create on paper.
What is envelope budgeting?
Envelope budgeting is an all cash budgeting technique. You decide how much money you are going to spend on a specific type of purchase, put that cash in a labeled envelope, and then use only that cash for making that type of purchase. You can replenish your envelopes monthly or each time you receive a paycheck, depending on your preferences.
Steps to set up your envelope budget system
- Subtract fixed expenses, such as your housing payment, car payment, utilities, and credit card payments from your income to find out how much discretionary spending you have available.
- Divide your discretionary spending money between spending categories that match your spending habits. Allocate the amount you plan to spend in each category based on past spending habits or future spending goals. For this method to be effective, make sure to be reasonable, especially in necessary categories like groceries or gas. If possible, allocate money in $20 multiple amounts to make it easy to put the appropriate amount of cash in each envelope.
- Label envelopes with the categories you have determined and the amount of money you have budgeted for each category. If you would like something more durable and easier to keep tidy than a stack of envelopes, an alternative is to use a small accordion folder with tab dividers.
- Go to the ATM or the bank or credit union when it is time to fill your envelopes and withdraw the appropriate amount of cash. Divide it between the envelopes according to your budgeted amounts.
- Spend money only from your envelopes. If you have to make a purchase online with a debit card, immediately take that amount of cash out of the appropriate envelope and put it in an envelope labeled "deposit into checking account."
Replenish your envelopes each month or after each paycheck. You can either carry over remaining cash or take that cash out and use it to help achieve a financial goal, like paying down debt or saving money for a vacation.
Pros and cons of envelope budgeting
Consider the pros and cons of envelope budgeting to help you decide whether this is the right budgeting method for you.
Pros:
- Holds you accountable to your planned budget by making it very difficult to overspend. You see exactly how much cash you have left in each envelope and are not supposed to spend any other money.
- Easy to adjust budget to account for unplanned circumstances by moving money between envelopes.
- Cash spending is psychologically more difficult than plastic spending, so you are likely to spend less just because you are using cash.
Cons:
- Does not work as well if you frequently make purchases online, where you need to use a debit card or credit card rather than cash.
- Carrying lots of cash can be risky if you are prone to losing your wallet or live in an area with high instances of theft.
- Envelope budgeting within a family can be tricky because you are sharing the same cash envelopes. As a result, you might not always have the right cash with you when you need to make a purchase.