How to Use the Envelope System to Manage Finances
I’m a believer in the Envelope System to help those of us struggling to live below our means. If we’re overspending by using credit and/or debit cards, we need to remember that Cash is King. The Envelope System returns the King to his throne so that we can regain control of our spending.
Why The Envelope System Works
There is no shortage of budgeting systems, from pencil and paper to digital and cloud. The envelope system works well for most households for many reasons, not the least of which is that by separating available cash into pre-determined envelopes for specific spending purposes, it forces us to pay attention to our money. Short and simple. Too many of our households can name the current contestants on our favorite reality show but cannot say how much money we have available to spend at the grocery store this week. The envelope system is like the friend we had as kids who kept track of playtime after school to make sure we all made it home for dinner without being grounded. We did not want to stop playing, but we appreciated that friend all the same.
5 Basic Steps to Using the Envelope System:
Step 1: Identify Expenses
Make a list of monthly household expenses that cannot be set up on an automatic payment plan. E.g. groceries, entertainment, fun money, dining out, date night/entertainment, gasoline, gift giving, vacation, recreation, etc… These expenses will be included in our Envelope System.
Keep in mind that we should not use the envelope system as a replacement for short-term savings accounts or long-term investment accounts. I included Vacation money in this step thinking of a one-night or weekend getaway. Larger vacation funds should be placed in a financial institution account (savings, CD, money market, etc.). Having large amounts of cash lying around is unsafe and will likely lead us to spend it on other purposes.
Step 2: Determine a Place to Stow Cash
Choose an envelope-like receptacle where we can store cash and coins for each spending category we’ve identified in Step 1. Plastic pouches and small boxes or drawers work fine, but it’s called the “Envelope System” for a reason. Cash must be divided clearly.
Step 3: Budget Cash for Each Category
Determine how many bills in each denomination we’ll need for each of the categories in Step 1 and calculate the combined amount of all the categories altogether. We’ll want to know this for Step 4.
Step 4: Set a Start Date
Next, we should determine the best time to start. It’s likely best to transition at the beginning of a new month. We may also consider waiting until we know our expenses will be consistent for several months in a row. Starting in a high spend month such as December, for example, may stack the odds against us.
Step 5: Divide Cash from Paychecks Between Envelopes
When the first payday comes, withdraw cash from our financial institution account in the monthly amounts and denominations identified in prior steps. Then, place this amount in each envelope or chosen container. Paychecks are likely received twice a month. So it may make more sense to only take half of each category’s total budget per paycheck.
Step 6: Spend Wisely
Use only the cash stored in these envelopes for the purchases to which they correspond. We should not shuffle money back and forth between envelopes. As difficult as it may be, it is also important that when we shop, we leave our debit and credit cards alone. Instead of covering any overage with these forms of payment, we should forego the purchase or put back a couple items or our attempt to better budget our money will surely fail. We must practice discipline over and over again.
Step 7: Repeat
If our Envelope System doesn’t work the first month as we were hoping, we need to keep trying. It might take three or four months to get it down and running smoothly.
Keep in mind, it may take a bit of troubleshooting to work out the kinks. Perhaps we’ll need to change where we keep our envelopes so they are accessible when we need them. It’s also possible we underestimated some categories while overestimating others. So long as we are not reaching beyond the total amount we can afford and create a plan ahead of time, adjusting budgets for categories is well within reason.
Finally, if we stop using the Envelope System because we feel we’re back in control of our finances, we shouldn’t feel bad about going back on it if our spending starts to increase again. The System is a great friend who has our financial back anytime we need it.