Creating a reasonable budget and sticking to it are important steps to achieving financial success. The envelope budgeting system is one option for tracking spending each month.
This method requires dividing the available spending money into separate envelopes that represent your key spending categories. They can be virtual envelopes: The approach can be adapted for use with mobile budgeting apps.
Key Takeaways
- The envelope budgeting method can be low-tech if you prefer to use cash for your daily expenses.
- Or, you can use an app to create virtual envelopes filled with virtual cash.
- This method can be used to control spending by limiting total purchases to the monthly amount budgeted.
- The total amount in your envelopes is the spending money you have available each month after set expenses like rent and loan repayments are taken care of.
Understanding Envelope Budgeting
According to a 2022 Debt.com survey, about 85.6% of Americans say they keep a budget each month, and 90.24% say everyone should keep one. There are different approaches to creating a budget, including zero-based budgeting and annual budgeting.
The envelope budgeting system uses a cash-based approach. It can help people who struggle to stick to a budget to be more mindful of—and deliberate with—their spending.
You begin with multiple envelopes, each of which represents a budget category. You then assign a certain amount of cash to each one, based on how much you anticipate spending in that category for the month.
Once an envelope is empty, you can't spend any more money in that category until your new budget period begins.
Cash envelope budgeting can be adapted for use with mobile budgeting apps that allow you to create digital envelopes for tracking debit card spending.
How the Envelope Budgeting System Works
The envelope budgeting system isn’t complicated. There are, however, some specific steps to follow for setting it up.
Step 1: Add Up Your Monthly Income
Before you can begin using the envelope method to budget, you need to know your net monthly income. This includes all the money that you expect to bring in for the month. Your income sources may include:
- Paychecks from a regular job
- Earnings from a part-time job, second job, or side hustle
- Investment income
- Alimony or child support payments, if applicable
- Government benefits, if applicable
- Any additional windfall that you might reasonably expect
You may also include any one-time sources of income that you expect to receive for the month, such as tax refunds or rebates.
If you have irregular income from self-employment, you can establish a baseline average income by adding up your total earnings for the past year, then dividing the amount by 12.
Step 2: Set Budget Categories
The next step with envelope budgeting is choosing which categories to put in your budget. Omit fixed expenses like rent or mortgage payments and student debt payments. These are the expenses that can vary according to your decisions from day to day. They include:
- Groceries
- Transportation
- Clothing
- Dining out
- Entertainment
- Personal care
- Pet care
- Household items
- Gifts
Expenses for housing, utilities, insurance, and debt repayment are typically not included in envelope budgeting because they represent the fixed part of your budget—expenses that are non-negotiable and don’t change much from month to month. You probably pay these bills electronically or by check.
Your cash envelopes should represent the money that is left over after these necessities are taken care of.
Reviewing your bank statements for the past three to six months can give you a good idea of the categories in which you tend to spend the most or least, and when.
Step 3: Assign Budget Amounts to Each Envelope
Once you’ve determined your available spending money and chosen your budget categories, you’ll need to decide how much money to allocate to each.
Here’s an example of what an envelope budget might look like, based on average consumer expenditures for 2021:
- Groceries—$690
- Auto fuel and oil—$179
- Clothing—$146
- Dining Out—$252
- Entertainment—$297
- Personal Care—$64
- Miscellaneous—$82
Divide your cash up and jot down the amount of money each contains on the backs of the envelopes.
Step 4: Spend the Cash in Each Envelope
Once cash has been assigned to each envelope, put your budget to work by spending it to cover expenses.
Each time that you take cash from the envelope, subtract the amount from your total. For example, if you start off with $100 in your gas envelope and pay $25 at the pump, then jot that down on the back of the envelope. This allows you to keep a running tab of how much you have left to spend in each envelope.
The key to making the envelope budgeting system work is spending only the money that you have on hand. Say you have $690 assigned to your grocery envelope. If that’s your budget amount for the month, then you would be able to spend about $172 per week.
Once that money is gone, you wouldn’t be able to spend anything else until the new budget month begins. You could take cash from another envelope, but that will leave you with a shortfall in another budget category.
Using the envelope budgeting system requires a certain amount of discipline to avoid overspending. You'll also learn your priorities fast: food over entertainment, for example.
If you have money left over in your cash envelopes at the end of the month, you could add it to a high-yield savings account or use it to make an extra payment toward debt.
Pros and Cons of Envelope Budgeting
Understanding what’s good—and potentially not so good—about envelope budgeting can help you decide if it’s right for you.
Pros
Allows granular insight into monthly spending, avoiding overspending
Encourages the habit of tracking spending
Helps to save money
Cons
More time-consuming and tedious than other methods
May be easy to forget an expense
Not as convenient or secure as using a debit or credit card for certain purchases
When deciding whether to use cash envelope budgeting, consider your current spending habits. If you’re already disciplined about tracking your expenses, switching to envelopes may not be difficult. Also, consider where you tend to spend the most and whether paying in cash instead of using a debit or credit card makes sense.
For example, you could pay with cash when dining out. However, if you were to use a dining rewards credit card instead, you could earn some points or cash back on that expense, which could save you money, assuming that you pay your balance in full each month to avoid interest charges.
Is Envelope Budgeting a Low-Tech System?
Envelope budgeting is a relatively low-tech way to get a grip on your spending, although you can juice it up a bit by using an app instead of real cash and paper envelopes.
Its ease of use is part of its attraction. It makes budgeting doable for people who aren't into spreadsheets or complicated apps.
It also keeps a person keenly aware of where the money is going from day to day.
How Much Money Should I Put Into Each Budget Envelope?
There's no set amount. Just be realistic. You might go through your past expenses for a month or two and jot down the amounts you actually spent on restaurant meals, entertainment, and your other budget categories.
This might actually lead to some unpleasant surprises, and a commitment to cut back a bit on non-essentials in order to better fund the essentials.
Does Envelope Budgeting Rule Out Using Credit Cards?
It's true that cash is no longer king but a simple tweak can refit the envelope budgeting method to our increasingly cash-free system.
You can use the envelope budgeting method in a virtual fashion, creating your envelopes in a mobile budgeting app or in a simple document you create on your own. Use your credit or debit card as usual, but make sure you subtract your expenditures from day to day.
Most important of all, make sure you pay off all of your expenditures in full monthly. If you don't, you're blowing your budget and racking up additional interest charges.
The Bottom Line
The envelope budgeting system is a cash-oriented approach to budgeting, although you can use virtual envelopes instead of real ones.
Its strength is its simplicity. Over time, you may find it makes you a smarter consumer. You'll be fully aware of where your money is going from day to day, and better able to stay within your income.
