How to Use Envelope Budgeting

How to Use Envelope Budgeting

Let’s face it: maintaining a household budget is hard. Most of us are capable of creating a budget; just take your monthly income, distribute it to cover all of your mandatory monthly expenses, and use the rest as spending money, or put some into an emergency fund, or perhaps pay off some existing debt.

But, a problem arises as we go through our daily lives—it’s incredibly easy to buy things. You can swipe or tap your debit card at the grocery store. Your checking account is used for your online bill payments, and your credit card covers your online shopping. Lately, you can even use your mobile phone to pay for coffee and snack purchases.

All of these scattered purchases made with different payment methods play havoc with your household budget. It’s easy to lose track of how much you’ve spent on a certain budget item. It’s also easy to exceed your personal spending money on “nice to have” items, which further messes up the bottom line.

There are personal finance apps you can use to track purchases, but some people find it necessary to enforce more control over their monthly spending activity so they can meet their household budgets and maintain their personal finance goals.

One solution to this issue is a system known as envelope budgeting. Envelope budgeting is actually a throwback to the days when running a household was almost exclusively a cash business.

What is envelope budgeting?

Envelope budgeting enforces financial control by turning the majority of your spending into cash transactions. An envelope budget requires you to withdraw your earnings in cash and distribute the money into different envelopes, one envelope for each budget item.

Most of us can’t realistically turn all of our payments into cash transactions. If you are paying rent, you likely submit a monthly rent check; if you have a mortgage, your payment is usually auto-debited from your bank account. Your utilities (electricity, gas, etc.) are typically paid online.

That’s okay. These regular payments are rarely the cause of budget confusion, as you are aware of how much these expenses are and when they normally get paid. The envelope budgeting system we’re talking about is meant to prevent overspending in areas that are less predictable and more challenging to keep track of.

How do I set up envelope budgeting?

First, you must designate a budget amount for each item you wish to use envelope budgeting for. Here is an example of some potential monthly budget items and amounts:

  • Groceries (food items only) = $150
  • Toiletries and health products = $75
  • Fuel allowance = $50
  • Dining out = $40
  • Clothing = $75
  • Entertainment = $50

Using whatever type of envelopes you have, take one and label it with the monthly budget item it will be used for, and the budgeted amount for that expense. Do this until you have an envelope for each expense you want to track. Be as creative as you like; use different colored envelopes for each expense, or use stickers to differentiate them.

Envelope budgeting is a throwback to when running a household was almost exclusively a cash business. Click To Tweet

For this example, let’s assume you are working and getting paid every two weeks. When you get paid, withdraw enough cash to place half of the monthly budgeted amount into each envelope. You’ll do this every time you get paid while using envelope budgeting.

How do I use envelope budgeting?

This is where discipline comes in: use the cash in each envelope for the expense it is marked for, and for nothing else.

When you go to the supermarket, take cash from the Groceries envelope (or the entire envelope itself) and use it to pay the bill. If you’re going out for pizza and wings, take money out of the Dining Out envelope and leave your debit card at home.

The trick is to treat your cash on hand as the only form of payment you can use for the expense items you’re tracking. And, you should never use money from one envelope (Groceries) to pay for something that belongs to a different envelope (Entertainment).

This system will let you know within a couple of months if your household budget is realistic or not. If the cash in your Fuel allowance envelope isn’t keeping your car running for the month, you’ll know you need to increase the allotted amount, or add an option like public transit to reduce costs.

Likewise, if you consistently have cash left over in an envelope every month, you should reduce that budget item and add the saved amount to a different expense envelope, or target that money for your emergency fund or debt reduction.

Why does envelope budgeting work?

The envelope budgeting system works because it forces you to stick to your monthly expense allowances. When the Groceries envelope is empty, it’s time to rustle up some leftovers or make something from the ingredients you have on hand. If the Clothing envelope only has $10 in it, you have to wait until next month to buy that new pair of jeans.

Envelope budgeting is a very disciplined method of expense control, as it requires you to organize your life around your cash on hand, rather than rely on the convenience of payment cards and mobile phone apps.

Due to its strictness, some people choose to adopt envelope budgeting temporarily, say for a six-month period. This can still give you the feedback you need to locate “budget leaks” and tweak your monthly spending. When you return to using debit and credit cards, you will have a better idea of where your money is going. You will also (hopefully) carry over the discipline you developed when having to pay cash for many of your monthly expenses.

It’s also a good idea to create a Personal Financial Statement document before starting with envelope budgeting, as this enables you to track how you are doing with your finances over time.

Use envelope budgeting to control your monthly spending

If you regularly find yourself short of funds every month, you may want to take control of your spending by using the envelope budgeting system. Envelope budgeting is an effective way to manage your expenses, improve your discipline when it comes to “nice-to-have” purchases, and meet your financial goals.

Aaron Axline

Marketing Writer at LawDepot
Aaron Axline is an author, technology journalist, blogger, and knowledge management expert based in Edmonton, Canada. He likes cats.

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