The Envelope System
As mentioned before, the two side pieces on our ladder are the monthly budget and the envelope system. You hold onto these all the time you are climbing out of your money pit. While you move up the rungs of the ladder sequentially, you keep working your budget and the envelope system for the rest of your life. This keeps you from backsliding into old habits. You never stop doing your budget or using the envelopes.
What is “The Envelope System”? It is a money management tool where a series of envelopes are used to temporarily hold your money. Each envelope is for a different category in your budget. Envelopes are used for cash purchases during the month. They can also be used for short-term savings other than the emergency fund. The envelope system is to financial management like bread is to a sandwich.
Think about the areas in which you can spend by impulse or where the amount you spend is under your control--restaurants, groceries, department stores, etc. These are the areas where the envelope system will serve as a great friend.
Look at your budget and pick the categories subject to variable or impulse spending. For each of these categories (they will be identified with the word "envelope" in the second column of your budget form), you will need an envelope. Label the envelope with the category name. You don't need envelopes for fixed expenses, but you can do this if you would like. You also don't need envelopes for expenses that are paid through auto-withdrawal.
Let's run through an example. Let's say your first paycheck of the next month will be $1280, net pay. (Gross pay doesn't matter because you can't spend money the government keeps.) Let's also say that of this $1280 you plan on using $350 for groceries, $50 for gas, $80 for restaurants, and $800 to pay the mortgage. Those expenses add up to $1280. Pat yourself on the back. You've done well--you've decided how all the money from your first paycheck of the upcoming month will be spent.
When you get that first paycheck, go to the bank and get $480 in cash. Specify the denominations for your $480--for example, 3 hundred dollar bills, 2 fifties, and 4 twenties. If you are going to write a check for the mortgage, you can deposit the $800 into your checking account so you can write the mortgage check.
So now you can write the mortgage check. And you're looking at $480 in cash. Take the $480 and put it in your three envelopes. All three of the hundreds and one of the fifties goes in the grocery envelope, the remaining fifty goes in the gas envelope, and the 4 twenties go in the restaurant envelope.
Let's recap:
Then--let's say--you go grocery shopping. As you shop, use a calculator, pencil, or smart kid to keep track of what you are spending. Your grocery envelope has $350 in it, so stay under your $350 limit. When you're done shopping, go to the checkout lane and have them ring you up.
If your math was correct, your bill should be under $350, YEAH! But--if you're like me and you did your math wrong--sometimes it will be more than what is in your envelope. You will then feel frustrated and embarrassed, and you will tell yourself the envelope system simply DOES NOT WORK. This is a lie. This is what is supposed to happen. Your envelopes are working great.
When it rings up $380 and you only have $350 in cash, you have a choice: either put some things back, OR pull out $30 from another envelope--probably restaurants, because eating out is less of a priority than groceries, gas, or the mortgage. When you ring up more than what you have, the envelope system is doing its job. That's its purpose--to keep you from spending money you don't have. To help you consciously choose how you spend your money.
But now you just have $20 in your restaurant envelope, and eating out doesn't look the same. This is true. But you've made that decision intentionally. This is an important point because in making this choice you have consciously taken control of where your money goes. You are now in charge of your destiny. Do this for a few months, and your whole world will open up in strange and beautiful ways.
When you get your next paycheck, treat it the same way. Your budget amounts won't be the same as the first paycheck because bills come due at different times of the month. But when you get the second paycheck, look at your budget and figure out how much of that paycheck gets deposited in your bank accounts, how much you need back in cash to feed your envelopes, and what denominations you need your cash in. Be careful. If you need $851 in cash for your envelopes and you get that in 8 hundreds, 1 fifty, and 1 one, it will be hard to split up in your envelopes. Get the picture?
At the end of the month, many of your envelopes will be empty, but you may have a few dollars left over. You can move this wherever you want--leave it in the envelope for the next month, move it to a different budget category, or gift it to that single mom down the street.
The main complaint I hear about the envelopes is that people don't want to carry around that much cash because it might get stolen or lost. This is true. So when you go out just take the envelopes you need for that trip, guard them closely, and put your name and phone number on them for those honest people who will want to return them if found.
In reality, the envelope system is worth the risk, because it is the best tool in the world for wise money management. Let me say that again: The envelope system is the best tool in the world for wise money management. Whether you are living paycheck to paycheck, or you are wealthy beyond belief, the envelope system makes you accountable for your financial stewardship.
Here are some tips on using envelopes:
- Depending on your budget, you may have 5-20 budget categories you want to keep in envelopes. It is important, at a minimum, to use envelopes for gas, groceries, and restaurants. These are areas where overspending is most common. A typical household with kids has about 6-12 categories that should be kept in envelopes.
- You can purchase envelope systems, or you can create your own. Cheap coupon holders work fine and are reusable from month to month. Some people get extra envelopes from their banks. Other people use regular envelopes held together with a clip or a rubber band. They all work.
- When you first start using envelopes, you need to keep an eye on where your money is going. For examples, is grocery money being spent at big groceries and wholesale stores, or at the local convenience store? There is a big difference in cost for items. For the first few months of keeping your budget, write down on the envelope where your money is going each time you take money out. You can keep it simple by just recording the date, the name of the store, and the dollar amount. At the end of the month, you can review your spending habits to see if any of your habits surprise you. When you reach a point where you feel this step is unnecessary, stop doing it. This step is not necessary for budgeting pros.
- You may want to consider keeping 2 sets of envelopes: one for monthly day-to-day spending (gas, food, restaurants, etc.) and another set for savings that you don’t dip into regularly (organizational dues, car replacement, car repairs, etc.). The first set can stay with you, and the second set can be hidden in the house somewhere. This helps you keep the discipline of short-term savings, while not carrying around large amounts of cash.
- If you are married or budgeting with a partner, you may want to create two sets of envelopes for such things as impulse spending, restaurants, and gasoline. Consider having a "his" gasoline and a "her" gasoline, for example. You can then have one set of envelopes that one of you keeps, and the other person can keep their set.
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