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The envelope budgeting system has been around for decades. The system is relatively simple. Consumers come up with budget categories and create envelopes for each category.
They come up with the amount of money they can spend in each category, and they stuff that amount of cash into the envelope. Then, when they spend money, they take it directly out of that category’s envelope.
This system was designed for people who tend to overspend in certain categories. It holds them accountable and makes it difficult to overspend.
Example of the Envelope Budgeting Process
Joe analyzes his budget and realizes he overspends in certain areas. He sets up categories for these areas. For this example, let’s say those categories are entertainment, groceries, and eating out.
He decides he can spend $300 a month on entertainment, $400 a month on groceries, and $200 a month on eating out.
He takes out three envelopes and writes the category name on each envelope.
Joe gets paid two times a month. For his first paycheck of the month, he puts half of the amount in each envelope. Then, he puts the other half in when he receives his second paycheck.
He decides he’s going to see a movie. He picks up his entertainment envelope and takes out the cash for the movie. That includes all the expenses he incurs during the movie, such as drinks and popcorn. He is not allowed to use a credit card for any items at the theater. It all comes out of his envelope.
Next, he goes to the grocery store. Again, the money he spends must come out of that envelope. He is not allowed to charge anything. He spends $100 at the grocery store, so he has $300 left to spend.
Finally, he wants to go to dinner with friends. He takes his envelope along and pays for his meal out of it.
He continues doing this all month long. It’s getting close to the end of the month, and he decides to meet some friends for dinner. He picks up the corresponding envelope and realizes it only has $2 in it. He can order something off a fast food dollar menu or he can skip a meal out altogether. He’s run out of money for his meals out, so he has no other option.
Benefits of Using the Envelope System
The envelope budgeting system has several advantages. Let’s take a look at the benefits of this system to understand why it’s so popular.
It Builds Discipline
It’s hard to be disciplined with a normal budget. Consumers often talk themselves into charging something outside of their budget. “It’s just a few dollars,” they’ll tell themselves as they pull out their credit cards. Those few dollars add up over the course of the month and can kill a budget.
Those who follow the envelope budgeting system don’t have that option. When their envelope runs out of money, they are out of money. This creates discipline that makes it easier to hit budgeting goals.
The envelope budgeting system is cash-based. Cash is tangible. Consumers hold it in their hands and understand the value of it. This is a far cry from credit cards. It’s hard to forget that credit cards are connected to money, and that makes it easy to overspend.
It’s Easier to Balance
Consumers who use credit and debit cards often don’t realize how much they’re spending. Their budgets are out of balance because of this.
The envelope budgeting system allows consumers to set a balance for all transactions at the beginning of the month using cash. Their budgets stay on point because they’ll either meet their budget cap or spend below it, making it easier to hit budgeting goals.
No More Overdraft Charges
Even people who keep a close eye on their spending can end up with overdraft charges from time to time. That’s the risk of using debit cards.
This budgeting system is cash-based, so it eliminates overdraft charges. That means consumers stop losing money to fees.
Drawbacks of Using the Envelope System
While the system works for a lot of people, that doesn’t mean there aren’t any drawbacks. Here are some of the issues with this system.
It Doesn’t Account for Price Fluctuations
Prices can go up from time to time, and price increases can throw cash budgets out of whack. Imagine having a gas envelope, and the price of gas goes up 50 cents overnight because of a crisis. It happens, and it might mean that consumers run out of gas money before the month is up.
Prices also go up for groceries and other items. Consumers have the option of changing their budgets the following month to accommodate these increases, but they’ll be stuck until the next month rolls around.
It Adds Another Errand to an Already Full List
People tend to be busy, so the idea of going to the bank to withdraw cash might be overwhelming. Just adding one more item to the errand list can be too much for some people to bear.
There’s a Learning Curve
Some purchases aren’t straightforward, so there is a learning curve with this system. Imagine going to the store and buying groceries, household items, and some clothes. The money will come out of different envelopes, so consumers must get used to analyzing their purchases.
Those who like to get credit card rewards won’t love this system. Credit cards don’t offer rewards for using cash.
Alternatives to the Envelope Budgeting System
Those who want to keep a tight budget without using this system have other options. They can keep a spending journal to track all expenses or get an app that tracks spending. Both provide useful visuals that consumers can use to track their money.
Which Option is Best?
Consumers need to find the budgeting tool that works best for them. For some, that tool is the envelope budgeting system. Others prefer writing items down or creating cool posters. Still others like to use credit cards to collect rewards.
It’s important for consumers to find the tool that works best for them and then use it accordingly.
Author: Jeff Gitlen, CEPF®