One budgeting method that has been made popular by Dave Ramsey is the envelope budgeting system. Instead of paying all your bills from one giant “slush fund” also known as your bank account, you keep the money for your monthly budget items in separate envelopes to prevent overspending. Can the envelope budgeting system work to actually save you money?
What is the Envelope Budgeting System?
The envelope budgeting system is one way to organize your finances. If you are currently in the process of improving your money management skills and creating a spending plan, the envelope system can help ensure you do not overspend in any budget category.
When the system was originally introduced, cash was still the preferred payment method for most consumers and stores. Debit and credit cards existed, but, they were still mostly used for “big” purchases. Thankfully, you can still practice the envelope system the “old-fashioned” way with paper envelopes or online at Mvelopes. There is a small monthly fee ($4 each month) for the online version from Mvelopes.
Digital envelopes can be linked directly to your bank account or credit card. You can categorize each purchase to fit within each envelope. It’s not quite the same experience as spending with cash, but, you can still be held accountable to your budget.
Focus on Your Trouble Spending Categories
You most likely will not be able to use the envelope system for every single expense you have. While you might be able to pay your electric bill in person, your mortgage servicer that is located six states away will not accept cash payments.
Using paper or digital envelopes, focus on your disposable income. This is the money left over from each paycheck after you pay your taxes, insurance premiums, rent/mortgage, and retirement accounts. You use your disposable income to buy groceries, put gas in your car, and pay for your child’s music lessons.
Make envelopes for these spending categories and put the specified amount of money in them each month. For example, if you will put $100 a month into the gasoline envelope if you plan to spend $100 a month in gas to get around town.
If you don’t want to fiddle with digital envelopes (yet), you can also just choose three or four spending categories that you can pay cash with. Some examples might include clothing, groceries, dining, gas, and entertainment.
Only Spend What’s In the Envelope
The secret to making the envelope budgeting system work is only spending what is in the envelopes. One reason you might not be financially healthy at the moment is that you are not tracking your spending or not following a budget.
Once you spend all the money in the envelope, you do not “borrow” from another envelope to keep spending more. If you continue to borrow from other envelopes, you risk spending from your retirement savings, saving for your emergency fund, or your debt payments.
This is a visible way to see what it means to “live within your means.” At the end of each month, if you have extra money remaining in other envelopes on a consistent basis (i.e. you only spend $50 of the $100 you budget for clothing), you can reduce the amount of money you will put in those envelopes in upcoming months and begin putting the difference in the envelope(s) where you run out of money each month.
Only Borrow Mid-Month for Emergencies
The only time you should borrow from other envelopes is when there is an emergency. An example might be if your fridge breaks and you need to throw everything out and need to spend extra at the grocery store to replace all the spoiled food. You can shift money from other envelopes to make up the difference to avoid borrowing from your emergency fund.
These are just “one-off” events. Not every unexpected spending event is an emergency. If you are borrowing money each month, you need to reanalyze your spending habits to see if you can reduce spending in other areas to compensate for the larger spending in other categories.
Put Your Extra Money To Work
At the end of each month, put your remaining money to work. If you know a large expense is coming up soon such as family vacation, repainting the living room, or back-to-school shopping. Put the money in a special account or envelope specifically for that purpose so it doesn’t get mixed in with your regular monthly spending. You might also decide to use the money to make an extra loan payment or an extra IRA contribution.
Advantages of the Envelope Budgeting System
You might like the envelope budgeting system for the following reasons:
- Organizes your spending
- Sets limits on how much you can spend each month
- Allows you to accurately see how much “extra” money you have each month
- Prevents overdraft charges and bank fees
Disadvantages of the Envelope Budgeting System
There is much to like about the envelope system, but, it isn’t a perfect option:
- Not every expense can be paid with cash
- Digital tracking still might miss some purchases
- Can take a few months to not being able to “borrow” from other envelopes
- Do not earn credit card rewards
There are many different ways to budget and track your spending. That is the beauty of personal finance because you have options to do what is best for your circumstances. The envelope budgeting system is another tool that can help you out. Even if you do not use it long-term, it can be a great way to understand and visually see how you spend your money on a monthly basis.