envelopes http://www.wisebread.com/taxonomy/term/6742/all en-US Your budget: envelopes or a plan? http://www.wisebread.com/your-budget-envelopes-or-a-plan <p><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/wisebread_imce/budget-envelopes.jpg" alt="Budget envelopes" title="Budget envelopes" width="399" height="279" /></p> <p>When I was first introduced to budgeting, the model used was the envelope method. Every payday you&#39;d take your cash and divide it up among envelopes labeled &quot;Rent,&quot; &quot;Groceries,&quot; &quot;Electric Bill,&quot; etc. Then, when it was time to shop for groceries or pay a bill, you&#39;d take the money out of that envelope.</p> <p>Just to be clear, even I&#39;m not old enough that anyone I knew ever used actual envelopes. We&#39;d keep the money in a money market fund or savings account (nowadays probably an internet savings account), and use a spreadsheet (or paper) to keep track of the categories. But the model was envelopes.</p> <p>The envelope method works especially well with occasional or irregular expenses like annual insurance bills or car repairs. You put, say, $52 every month into the &quot;Car maintenance&quot; envelope. Every three months you pull out enough for an oil change, letting the rest accumulate against the day when you need new CV joint boots or a new timing belt. There&#39;s the danger that you&#39;d need a new muffler right after you start budgeting, long before you&#39;ve accumulated the money for it--but you&#39;d have had the same problem even if you hadn&#39;t started budgeting.</p> <p>So, that&#39;s the model I used when I first started budgeting: I set aside a certain amount of money out of each paycheck for each category.</p> <p>Some years back, I used Quicken for a while, and found myself frustrated by the software&#39;s budgeting functionality. Following the envelope method to smooth out the occasional big bill didn&#39;t work the way I wanted: My &quot;car insurance&quot; line would show up as way <strong>under</strong> budget month after month, and then show up as way <strong>over</strong> budget the money I actually paid the insurance bill. More recent versions of Quicken partially solved the problem by letting you indicate exactly when a line item is due, so you can put in an annual bill, and then Quicken will show you the monthly average, but it still didn&#39;t do what I wanted for the situation where you wanted the budget to show gradual accumulation against an unpredictible event.</p> <p>Partly because of that experience, though, I&#39;ve found my mental model of budgets has changed. I don&#39;t see a budget as a bunch of envelopes, each with the money for some category of expenses. I see a budget now as a plan, with a pool of money to support my plan as a whole.</p> <p>For one thing, this solves the problem of that unexpected muffler expense: You add the item to your plan and you readjust other line items as needed to bring your spending in line with your resources. The money comes out of the pool of money that you&#39;ve got--which is just what you&#39;d have done with the envelope method as well, but now you&#39;re not having to raid all those envelopes for spare cash. In the budget itself, you note the actual expense in the month you pay for it and deduct that money from the balance that remains available this year, and then evaluate where you are in terms of the budget. Maybe you&#39;re still on track, or maybe this expense suggests that your budget was overly optimistic. If your best estimate says to adjust the budget, do so. </p> <p>The advantage of this mental model--the budget as a plan--is that a plan is what it really is. It&#39;s not just a bunch of categories with dollar amounts attached. Like any plan, it needs to change as reality intrudes--and as your hopes and aspirations change, but even as it changes, it remains a plan. </p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/your-budget-envelopes-or-a-plan">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. 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