A Comprehensive Guide to the Envelope System
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like Mint and MoneyStrands, along with their smartphone apps, may make the envelope system of budgeting seem quaint or outdated.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?