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August 25, 2005
Envelope Budgeting
This post is part of the Budgeting Mini-Series.
Envelope budgeting is a style of budget that guarantees you don't spend more money than you have allocated for a particular category.
How it works
The concept is pretty simple -- when you get paid, you divide all of your money into envelopes. Each envelope represents a different expense category.
There's an envelope for your mortgage or rent, one for the utility bill, for your groceries, for entertainment and eating out... whatever best fits your pattern of monthly expenses and your budget.
When you need to pay a bill or go shopping, you take money out of the appropriate envelope and spend it. When it's empty, you don't get to spend any more money in that category until next month. Simple!
Getting started
The first step is to determine how much money to allocate in each envelope. If you're highly attuned to how you spend your money, you might know what these are right away. But you will more likely need a couple months to figure out the approprate amounts.
There are a couple camps on how you should work savings into your envelope budget system. One says that any money left over in an envelope at the end of the month is your savings.
But I strongly recommend that you allocate money separately for savings. I, as I believe most of us do, tend to "clean my plate," financially speaking. If there's money allocated to a particular category, I'll probably spend it.
If you do have money left over in an envelope, you might save that also, but don't make it your only source of savings.
Non-cash options
There's something about this budgeting system that works well with cash. It's a physical representation of how much you can spend. You get to see it dwindle down each month, and that makes it a little harder to spend quite as much. It also keeps you honest. If your money's physically separate, you're less tempted to cheat and pull from another category.
Still, cash today can be inconvenient or even impossible to use in many cases. Since the point of the envelope budget is to keep you from over-spending, this isn't a big deal for fixed expenses where you spend the same amount each month (e.g., mortgage).
But for things like clothes and entertainment, it is much more difficult to use this system if you're not using cash. If you want it to work without cash, you need to religiously track your expenses and which category they belong to.
There are some technology-based options that can help . We have touched on this briefly before in this question about virtual accounts in finance software.
If you use the envelope budgeting method, or something similar, please share your experience and advice in a comment!
Posted by Frank at August 25, 2005 8:18 AM
Comments
Posted by: Ang.
at August 25, 2005 9:53 AM
My wife and I use envelopes for about 8 of our 25 to 30 budget categories. Over our six years of doing this we've found what categories we like in envelopes and what categories we like to use our debit card for (but we are now experimenting with an AMEX Blue Cash card). For example, even though Groceries would give us a good rebate on the Blue Cash card, we couldn't stand not knowing on a daily basis how much we had left at the end of the month.
Posted by: Mark
at August 25, 2005 1:28 PM
Dave Ramsey recommends the envelope system. I haven't tried it yet. I use multiple checking accounts and move money around that way...
Posted by: Tim
at August 26, 2005 1:22 PM
I find using financial software like MS Money or Intuit Quicken works great, especially if you’re comfortable using online banking (as importing statements automatically beats typing)! For each transaction, you can categorize it. After a while, it does a pretty good job of assigning the appropriate categories automatically. Also, the auto-budgeting features are pretty sophisticated. I can quickly see how much I spend on everything from mortgage payments & utilities top gasoline & car payments to eating out and watching movies. Once it builds up a month or so of history, I find that it’s extremely accurate in forecasting my income and expenses.
Once everything’s setup, it’s easy to set a savings goal and see what things in your budget (e.g. eating out) can be cut down to meet that goal. Similar to the “Envelope Budgeting” method, if you find yourself going over budget, the software will flag it for you.
Posted by: Jeff
at August 28, 2005 4:26 PM
I used the envelope system for about 1 year. I got the idea from Dave Ramsey. It worked very effectively.
At the time, I had a monthly stipend of $150 (not much, I agree, but all my living expenses were provided while I was in this school). I was able to save a lot because it helped me not to cheat, and I spent less. I couldn't use any plastic because all my money was in cash, and it's harder to spend cash because you "feel" and watch the money leave you; you see immediately how much you have left for the rest of the month. I had about 20 envelopes.
I stopped using it because of not having a local bank branch (I moved), the inconvenience of having to denominate everything out each month, and having to carry around all that cash all the time. Also, I would like it if my dollars that are just sitting in envelopes to earn some interest while they're just sitting there. For months I thought about how to resolve these issues but wasn't able to come up with anything that would save me very much time and wouldn't require me to learn some heavy-duty accounting. So, I stopped, and now my savings are just sitting in a savings account with nothing designated for anything. I am not happy about that.
I still have about $250 in the envelopes and I can't bring myself to take the money out of them because I know those dollars are designated; I can't cheat those dollars. This also goes to show how effective it is.
I want to reinstate the envelope system but would like to do it electronically so I can earn interest (at least for the big purchases) and maybe the enveolopes for my monthly stuff (groceries, gas, etc).
Someone elsewhere posted that ING Savings will let you create lots of little accounts. This might be a solution, but I haven't looked into it.
Posted by: John Martin
at August 28, 2005 9:55 PM
With all due respect, you are all over thinking the problem. Simple spreadsheets, virtual envelopes, mathmatically combining your accounts into 3 physical, primary accounts, and the secret of averaging your income/expenses is the key to brainless money management. I've been doing it the same way for over 15 years. And when I say "doing it", I mean I do so little that my time and brain power are directed toward other things in my life. I was asked about and have explained this process so many times to people that it was taking to much of my time. So here you go: http://www.thebword.com
Posted by: Lee Roesner
at September 3, 2005 10:25 AM
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My mother is a big fan of the envelope budget. She used it years ago, before I was born, when my parents were preparing for my dad's retirement from the military. When I was younger she would preach it to me, but it just didn't work for me. And now, almost everything I do is online and I hardly ever use cash at all. In fact, I find that I go through cash much quicker than I do when I use my debit card.
I think the fundamental principle is still sound - allocate amounts to categories. I just think the form is a little outdated now.