A Comprehensive Guide to the Envelope System

Matt Bell — Thu, 22 Sep 2011 10:24:22 +0000

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like Mint and MoneyStrands, along with their smartphone apps, may make the envelope system of budgeting seem quaint or outdated.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 20^th 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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This article is from Matt Bell of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Prepaid Gift Cards for Modern Envelope Budgeting

Paul Van Lierop — Tue, 18 Aug 2009 21:00:03 +0000

Envelope budgeting -- what is it? It’s an incredibly simple but powerful way to manage your money. At the beginning of the month or pay period you decide how much money you want to spend and in what category. If you are already actively budgeting this should be straightforward but if you are just starting out you might want to pick some of your problem areas. For my family that was groceries and eating out. So we make our budget and get out cash for each category, slap it in an envelope and Wazaam! You’re envelope budgeting. When there’s no more money in your envelope you stop buying things. It’s a dirt simple system that your great grandma may have used. But what if you want the flexibility of a check or credit card and don’t want to carry all that cash around? Enter in the electronic envelopes.

Prepaid Gift Cards

Head on down to your local bank or credit union and odds are they’ll be happy to provide you with a gift credit card that you prepay like Visa Buxx or some other options. The one downfall of these cards is they are rather difficult to reload with cash, and may have various fees that go along with them. Well, there is one more unconventional option that wasn’t necessarily designed for you.

Paypal Student Cards

Yeah, that’s right: a student card. Paypal has recently rolled out a new account option that lets you give junior a Mastercard Check card that you can refill from your paypal account. There are no fees for using this card other than a $1 charge for pulling money out of an ATM. Yeah, great, but I don’t have any kids. No worries as there is nothing stopping you from getting one in your name our your spouse's. Transfer some money from your Paypal account and you are ready to head out to the grocery store. Now, it’s not likely that you are going to get a prepaid card for every category. One approach is to bundle all those categories into one card, but it does remove some of the benefits of having distinct categories from the traditional envelope budgeting method.

Envelopes Vs. Prepaid Cards

If you are seriously interested in starting down the road of envelope budgeting or a prepaid option it’s good to know some of the pro’s and con’s of the prepaid card route versus standard cash envelope budgeting.

Prepaid Card Pros:

Ease of payment anywhere Mastercard is accepted
Consumer protection in the event the card is lost the funds can be replaced
Carry a single card rather than large amounts of cash
Works internationally with fees for currency conversion
Prevents overspending because it’s prepaid and not a credit card

Prepaid Card Cons:

More likely to spend more than if paying with cash
Potential Fees for reloading and ATM’s
Daily limits of Paypal Student card limited to $650 ($150 from an ATM and $500 in purchases)
More difficult to maintain multiple cards for multiple spending categories

envelope budget