Budgeting is a crucial aspect of effectively managing your finances. Without it, you are at risk of stretching yourself beyond what your finances can cover or even running into debt. The envelope budgeting system is a simple but effective way to gain control over your spending and ensure that you make the most out of your income. In this article, we will delve into details about what the envelope budgeting system is, how it works, its pros and cons, and other practical tips you would need.
Key takeaways
- The envelope budgeting system is a cash-based budgeting method that favors those who primarily spend cash.
- The budgeting system works by allocating a set amount of cash for different spending categories in labeled envelopes.
- To make the most of your income, the envelope system requires you to prioritize spending on necessary expenses such as food, housing, and transportation before other discretionary spendings such as entertainment and lifestyle shopping.
- The envelope budgeting system can be used alongside other conducive and relevant budgeting methods.
- It is important to stick to the budget in order to see results with the envelope budgeting system.
What is the envelope budgeting system?
The envelope budgeting system is a deliberate system for budgeting income by allocating funds for different purposes into separate envelopes. Each envelope represents a distinct category of spending, such as transportation, groceries, or debt payment. Funds are then put in each envelope out of the monthly income, based on how much is projected that each spending category will take or based on another budgeting strategy that is being used hand-in-hand with the envelope budgeting system.
Envelope budgeting requires putting cash in different envelopes. This meant that you would have to withdraw (or collect) all the cash you intend to spend for the month and then allocate them into envelopes. However, you can also adapt the envelope budgeting system for use with mobile budgeting apps or mobile banking providers that allow for the creation of digital envelopes. You may also choose to create several accounts with one or different banks to serve as separate envelopes for fund allocation.
The trick envelope budgeting does is that you get to physically see how much you have left to spend in a particular category. You also understand that once the money in the envelope is gone, you’ll be left with nothing to spend. All of this helps you to stay frugal and disciplined so that funds in the envelope can be sustained till the end of the budgeting period.
How does the envelope budgeting system work?
The envelope budgeting system is really simple to follow. Here is a step-by-step guide on how it works:
Step 1: Take a critical look into your monthly income
Before you begin allocating funds, it helps to have an idea of, or even have an exact figure of what your monthly income is. Factor in all sources such as salaries/wages, earnings from side hustles, returns on investment, allowance, government benefits, supports, etc. If you are the type that does not earn a fixed salary or have multiple sources of income, it is very possible that income sources would fluctuate per month. It is therefore always important to keep doing this check, so you know how much you have to work with for the month you are budgeting towards.
Step 2: Create spending categories or envelopes
The next step is to create spending categories that each envelope will represent. This requires you to group your spending into major categories. The important categories you should include are:
- Groceries and food
- Transportation
- Personal care
- Clothing
- Home care
- Children care
Others may include:
- Pet care
- Entertainment
- Eating out
- Medicine or healthcare
- Debt payment
- Savings
- Gifts, etc.
A quick way to recognize what you tend to spend money on per month is to look into your bank statement for up to three or six months and check the descriptions that accompany your transactions and where those funds go to.
Typically, expenses like mortgage, housing, and other utilities are not created in the envelope budgeting system because they are fixed and do not often require now-and-then spending. You would just have to sort them out on a monthly or annual basis.
Step 3: Allocate budgeted funds to each envelope
The next and most tricky step in the envelope budgeting system is allocating specific funds to each envelope. It is important to do this right or you may end up cheating on certain categories while assigning too much to others.
Start by catering to your fixed expenses like housing and utilities. The remainder of your income would then determine how much you’d allocate to all the envelopes you’ve created. It may help to carry out this step using other conducive and relevant budgeting strategies such as the 50/30/20 budgeting rule or zero-based budgeting. In fact, budgeting strategies like the 50/30/20 budgeting rule can help you to be more intentional and strategic with fund allocation so you can maximize savings or separate funds for debt payment.
Step 4: Spend only the cash in each envelope for its specified reason
How to make your envelope budget effective is by strategically watching how you spend so that you have enough in each envelope to take you through the budgeting period. You might even note down how much you’ve spent from each envelope at the back of the envelope so you know how much is left and can be constantly reminded of how frugal or extravagant you need to be for the cash to be sustained.
Once each envelope is empty of the cash allocated to it, it becomes imperative that you no longer spend more money on that category until a new budget cycle begins. Otherwise, you would be borrowing from or cheating another envelope such as your savings or another spending category. You may also end up cheating the funds that should be part of your next budgeting cycle by spending out of it before the new cycle begins.
Advantages and Limitations of Using the Envelope Budgeting Strategy
The envelope budgeting system is highly effective and comes with several advantages and a few significant limitations as well:
Advantages
- It offers deep insight that enables you to track where your money goes.
- It creates discipline and helps to prevent overspending.
- It keeps you accountable and truthful to your financial goals.
- It creates a highly effective system for savings or debt payment.
Limitations
- It tends to be more time-consuming and tedious than other budgeting methods out there.
- It hardly factors in emergencies so you can get stranded if they occur.
- You could easily forget an expense and not allocate cash for it.
- May not be very convenient if you carry out transactions using both cash and e-banking methods as you would need to watch your spending closely and do a lot of recording so you don’t mix things up.
What happens if I don’t use up the money in my envelope at the end of the budgeting period?
The goal is to make sure you have enough in each envelope to take you through the budgeting period. But what happens if you have left over in one or two pockets at the end of the month? Congratulations! This only shows how disciplined you’ve been with your spending all through that month. You might consider adding the leftover to your savings, or investment, or as an extra payment towards paying your debt. You could also reward yourself for this feat by eating out or getting a special haircut using the cash left or you could carry this cash over to the next budgeting period so you have enough to get some extra treat on groceries, dining out, or clothing.
Nevertheless, it is important to remain truthful to yourself when budgeting. If you keep having leftovers, it could mean that you are allocating way too much to some spending categories and you should consider cutting the budget so you have more to save towards strategic financial goals such as retirement or purchasing your home.
Conclusion
Most times, we tend to overspend only because there is no system granting us a sense of limit and informing our minds to stop. The envelope categories you create in the envelope budgeting system can be all the voice you need to put a limit to how you spend. Unlike when you remove money for all your spending from one purse or account, this budgeting system also helps you to visualize how you spend your money so that you can truly see how much you’re spending in real-time, how much is left, and what seems to be taking the most out of your income. With the envelope budgeting system, there are no illusions or grey areas. Everything about your spending becomes real to you, and this is why we recommend it to anyone and everyone!
