A Comprehensive Guide to the Envelope System

by Matt Bell on 22 September 2011 18 comments
Photo: abu

The availability of cool online budget tools like Mint and MoneyStrands, along with their smartphone apps, may make the envelope system of budgeting seem quaint or outdated. But the envelope system is one of the easiest and most effective budget tools available. Here’s your guide. (See also: 8 Tips for Improving or Starting a Budget)

What Is The Envelope System?

Let’s say you set your grocery budget at $400 per month. You take $400 in cash and put it in an envelope marked “groceries.” When you go grocery shopping, you bring that envelope with you, pay for your groceries with the money in the envelope, put the change back in that envelope, and keep going until your next payday.

One of the envelope system’s best benefits is how real it is — how tactile, how tangible. Let’s say it’s the 20th of the month and you’re wondering how much you have left in your clothing budget. Just look inside the envelope marked “clothing” and count the cash. It couldn’t be simpler.

How to Set Budgets for Each Category

To get started, download and fill out a Cash Flow Plan, a written plan for how every dollar of your monthly income will be used.

In the "Now" columns, write down how much you currently spend on each category. If you don’t know, just take a guess. Then use the "Goal" columns to create your ideal plan, one that allows you to pursue goals that are important to you, like getting out of debt or saving for the down payment on a house, while living within your means.

Not sure how much you should be spending on this or that? You can use my recommended spending guidelines (found at the same link above), which give detailed recommendations for nine different incomes and four different family sizes.

These are ideal plans, meaning they assume no debt other than a reasonable mortgage. If you have debt, you’ll have to make adjustments in discretionary categories like entertainment and vacations, but the guidelines should help you put together a viable plan.

Which Categories to Manage With Envelopes

Once you have a Cash Flow Plan, the next step is to decide where to keep the money for each category. Have your paycheck automatically deposited into your checking account. Then review my recommendations below.

For some categories, you’ll leave the budgeted amount in your checking account and pay the bill online or with a check.

For bills or expenses you pay less often than monthly, open a Periodic Bills/Expenses savings account. Each month, automatically transfer one-twelfth of the annual cost of all such bills or expenses added together from your checking account to this savings account. When the bill comes due, you’ll be glad to have the money sitting in savings.

For all remaining categories, withdraw the total budgeted amount in cash and fill appropriately labeled envelopes.

Have $75 budgeted for clothing? Put $75 of cash into an envelope marked “clothing.”

Outgo and Where to Keep Each Category

Here are the main budget categories and my recommendations as to which ones are best suited to the envelope system.

  • Allowances: Envelope
  • Barber/Beauty: Envelope
  • Books: Envelope
  • Bus/Train/Parking/Tolls: Envelope
  • Cable/Satellite: Checking account
  • Clothing: Envelope
  • Cosmetics: Envelope
  • Debt Payments: Checking account
  • Dry Cleaning: Envelope
  • Education (miscellaneous): Envelope
  • Education (fixed monthly costs): Checking account
  • Food: Envelope
  • Furniture/Household: Envelope
  • Gasoline: Envelope
  • Generosity: Envelope
  • Gifts: Envelope
  • Health: Checking account or Health Savings Account
  • Health Club: Checking account
  • Hobbies: Envelope
  • Homeowner’s/Renter’s Insurance: Periodic Bills/Expenses savings account (if paid less paid less often than monthly. Otherwise, keep in checking.)
  • House/Apartment Maintenance: Envelope
  • Income Taxes: Automatically withheld
  • Miscellaneous: Envelope
  • Mortgage/Rent: Checking account
  • Pets: Envelope
  • Professional Services:Periodic Bills/Expenses savings account
  • Property Taxes: Periodic Bills/Expenses savings account
  • Restaurants/Movies/Concerts: Envelope
  • Subscriptions: Checking account
  • Utilities: Checking account
  • Vacations: Periodic Bills/Expenses savings account
  • Vehicle Insurance: Periodic Bills/Expenses savings account (if paid less often than monthly. Otherwise, keep in checking.)
  • Vehicle License/Fees: Checking account
  • Vehicle Maintenance: Envelope

How Often Are You Paid?

If you’re paid once a month, withdraw the monthly cost of all envelope categories added together each time you’re paid and fill the envelopes. If you’re paid twice a month, withdraw half of the monthly budgeted amount each time you’re paid.

If you’re paid every other week (26 times a year), base most of your monthly budget on two paychecks (24 paychecks per year). Then use the two “extra” paychecks to cover some of your periodic bills.

For example, let’s say you earn $50,000, which comes out to $1,923 per paycheck. Of that, let’s say you take home $1,500. Finally, let’s assume you pay about $3,000 in property taxes each year. Use those two extra paychecks each year to pay your property taxes, putting the amount into your Periodic Bills/Expenses savings account until the bill comes due.

Other Tips for Making the Envelope System Work

As with any budget system, expect some trial and error. When you go grocery shopping, do you really need separate envelopes for "food," "cleaning products," "paper products," and "health & beauty aids," or can you just call it all "groceries"? You decide what works best for you. Keep these other tips in mind as well.

Use a Back-of-the-Envelope Tally

When you spend money out of an envelope, write the date, the place where you spent the money, and the amount on the back of the envelope. This record will be helpful to you at the end of the month as you think about ways to manage that category more effectively.

Be Flexible in Defining Categories

Should that pizza you ordered on Friday night come from your “groceries” envelope or your “entertainment” envelope? You decide. If you’re running low in your “groceries” envelope, use your “entertainment” envelope, or vice versa.

Robbing Peter to Pay Paul Is Allowed

In most envelope categories, draw a line and commit that when you’re out of money you’re done spending for the month. That’ll force you to get really creative. For example, if you run out of entertainment money, you may discover free things you can do for fun in your area that you had never known about.

However, if you run out of grocery money before the month is through, dumpster diving for meals isn’t much of an option. In that case, it’s okay to transfer money from another envelope where you haven’t spent the entire month’s allotment.

Know Which Envelope to Rob

If you have to raid one envelope to cover a shortfall in another, it’s best not to tap your home and vehicle maintenance envelopes. In those categories, you may not spend the full month’s amount this month, but you could easily need two or three months’ worth down the road, so let unspent money in those categories build up.

Are you an envelope system power user? What other tips do you have?

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Guest's picture
Jen H.

As frugal as I tend to be, I've found that using mVelopes as my envelope/budgeting solution has been worth the small fee. It's easier to keep track of of funds, and the history is helpful

Guest's picture
Guest

When my wife and I began on our road to financial independence 30 years ago, we used the envelope method in much the same way you describe it in your post, except we didn't do the back of the envelope tally. Using cash kept us in the real world. We didn't want to face an empty envelope before the month ended, so the envelope method caused use to ration our spending. We found that over time the budget becomes internalized and spending naturally conforms to the budget.

The envelope method is one reason we were able to retire at age 56.

Matt Bell's picture

Jen - I've heard good things about mvelopes as well. They describe it as an electronic envelope system.

Guest - Thanks for sharing an amazing testimony. What stronger endorsement of the envelope system could there be than being able to retire in your mid 50s? Congrats!

Guest's picture
Elizabeth S.

Great post. I have a pretty strict budget right now for most items, but groceries tends to get us. I have not done the envelope system before, and am thinking that it will help us tweak the smallest of details in our already laid out budget. Its too easy to use the debit card and go "over" our budgeted amount when you have money in the account.

Matt Bell's picture

Elizabeth - The envelope system can work really well even for just one or two "problem" categories, so using it to manage your grocery budget is a great idea.

Guest's picture
JustAGuy

We use it and it works. As long as we actually remember to bring the envelopes. When we don't the purchases go on the debt card and we "try" to remember to deposit that amount or take less the next month.

Biggest headache - our envelopes regularly disintegrate - we've tried tyvek and those don't fall apart just kind of loose their ability to stay in shape and still hold the money.

Matt Bell's picture

Just - I've seen people use those plastic pencil holders that look like heavier duty zip-lock bags. They cost more than envelopes, but they'll last a longer. You might give that a try.

Guest's picture
Tom

We use a "virtual" enveople system, EEBA (Android app - online at www.eebacanhelp.com), and it works great. You record every penny you spend in it's respective envelope in the app, and you can save a note/explanation of each transaction and even geotag the entry so you can look later to see where (literally) your money goes. My wife and I can both see the real-time balance info on our phones and enter our own spending without having to be in possession of the envelope of cash. We pay for everything with a single credit card, then write one check each month to pay off the card in full. (You can also use a debit card, but then you have to also balance your checkbook - double effort). It does take away a bit of the "pain" of the cash leaving your hands, which is a major part of the envelope system's effectiveness. But, we've found that when we stay diligent about entering the transactions in the app right as the money goes out, and have to look at the remaining balance and the # of days left, etc., it helps keep it "real" for us - unlike the usual experience of swiping a card. And then each month/quarter, we can sit down and run a detailed report of where the money has gone to help evaluate spending and adjust the budget as needed. I've tried a lot of other budget tools over the years, and this one simple tool has been the most useful thing I've found.

Matt Bell's picture

Tom - Thanks for sharing this info about EEBA. I had never heard of that before.

Guest's picture

We have used the envelope system for several years now. It is tangible, visual and it hurts more to spend cash. It has really helped us to keep our food budget reasonable and to pay more attendtion to where we are spending. The hardest thing for me to do was to not spend "My" fun cash on groceries or restaurants for the kids, but since I have changed that spending habit, I can enjoy little treats here and there for me, without messing up the evelope accounts.

Tip- if you rob one evelope to fund another at the end of the month, make sure you adjust thoses categories in the cash flow plan for next month, so that you are more realistic about your expenses.

Matt Bell's picture
Matt Bell

Kathryn - Great point about adjusting your cash flow plan based on which categories are getting overspent or underspent each month. When a budget is really humming, there should be little if any need for envelope robbing.

Guest's picture
Guest

I've used the envelope system for my Christmas budgeting for a couple of years now. It works great for me! Each week, I add a minimum $5 to the envelope. As a result, I don't have to put x-mas gifts on credit cards - I have the cash to cover them.

Matt Bell's picture
Matt Bell

Guest - That's a really good idea - sort of like your own Christmas club.

Guest's picture
Guest

We are new to the envelope system, which we have set up similar to your recommendations. One reason it has helped is because it keeps BOTH of us apprised of our spending - not just the one responsible for bill-paying. We now manage our money much better, particularly for groceries and "miscellaneous." I have the MealBoard app for my Ipad (also available for Iphone), which also makes it easier. The app allows me to create my menus for the week, then creates a shopping list with prices. I know before I leave for the store approximately what it will cost. It works amazingly well, though it took a while to get all the data entered.

Guest's picture

I use envelopes for budgeting too, but in a different way. Every time I spend, I would keep the receipts and put into different envelops. For example, food, groceries, entertainment, etc. At the end of every month, I would take them out and record the total for the month for a particular envelope. Over a few months, I would have learned how much to allocate each month. But be warned, this process is something I would try to avoid doing every month.

Guest's picture
electrogeek77

I wanted to save for a trip to NYC for a makeup artistry trade show, but I was scared that I couldn't do it due to my history of compulsive spending. So every time I was paid, after I took care of my bills, I would take whatever I wanted to save, place it in a sealed envelope, write that day's date, and the amount in the envelope. Then I asked my husband to keep it somewhere safe where it was out of my reach. Anytime I added more money from my paycheck or from something else(saving change, redeeming cans and bottles), I would use a new envelope. It helped a lot, and I wound up having a great vacation.

Guest's picture
Geoff

Well, there seems to be less going by mail nowadays, so putting envelopes to use in the ways suggested could be good way to budget properly.

Guest's picture
Guest

I use the envelope system for groceries, gas, and entertainment. As I get paid weekly, I break down the money from my budget and put it into the envelopes. At the end of the week I write down how much I spent. I then take all of the leftover envelope money from the week and put it into a 4th envelope "Emergency Fund". At the end of the month I calculate how much I saved and was put into the Emergency Fund envelope. I convert all of the money in the Emergency fund envelope into big bills ($100 or $50) so I am less likely to spend them.