The envelope budgeting method asks you to allocate cash into separate envelopes based on a spending plan you create ahead of time. You can go ahead and pay your mortgage, utilities and other regular bills with another form of payment, but you’ll rely on actual cash in envelopes — or their digital equivalent — to pay for discretionary expenses like groceries, gas and entertainment.
What’s the benefit of envelope budgeting? According to financial coach Steven Donovan, money management is 80 percent psychology and only 20 percent math. So, the big idea is to help users build positive financial habits.
“Our eyes see the cash coming out from the envelope and we understand mentally that money is not coming back in our wallets or purses,” Donovan says. “We actually feel the money leaving our possession.”
That’s much different than with a debit card or credit card, he says, since you don’t watch the money leave your possession and you may not realize the impact of your spending until later on.
How does envelope budgeting work?
The envelope budgeting method asks you to sit down and create a spending plan that makes sense with your income while covering all your regular bills and estimated expenses. Also note that you may be able to use a budgeting app to create digital envelopes. This is the case with Qube Money, an app that lets you utilize the envelope budgeting method with your smartphone thanks to digital envelopes, or “qubes.”
Emily Guy Birken, author of “End Financial Stress Now,” believes envelope budgeting is one of the most “intuitive” ways to handle pre-spending money management — mostly because you have to think ahead about your financial needs for the month. And while this budgeting method requires more work upfront, the end result is less math required once your envelope budget is set up and your envelopes are stuffed.
“You have given yourself guardrails around your spending so you don’t have to either constantly try to keep track of your money in your head or constantly try to bounce back from unintentional overspending,” Guy Birken says.
If you’re interested in envelope budgeting using physical envelopes and cash, here are the main steps you’ll need to take.
Step 1: Review your current expenses
Bob Lotich, a founder of SeedTime Money, says the first step you should take is to review your current bills and how you’re spending right now. That way, you can get an estimate of your current fixed expenses (mortgage, utilities, insurance, etc.), as well as how much you’re spending in miscellaneous categories.
If you already track your expenses, this part will be easy. If not, you can pull up your online banking and do your best to categorize your expenses over the last three months.
“Once you’ve done that, you will have a better idea how much money to allocate for each category going forward,” Lotich says.
Step 2: Set categories and limits
Once you have an idea of how much you spend each month, you’ll want to figure out some areas to cut. Maybe you’re overspending on subscription services, or perhaps you’re spending a lot more than you thought when you shop online. Either way, you’ll want to set limits for the main categories you spend in each month.
Here’s an example of how your written budget might look if your take-home pay is $4,000 per month:
- Mortgage: $1,100 per month
- Car payment: $350 per month
- Credit card bills: $200 per month
- Insurance: $200 per month
- Utilities: $300 per month
- Groceries: $700 per month
- Gas: $150 per month
- Entertainment: $150 per month
- Personal care (makeup, toiletries, etc.): $35 per month
- Home supplies: $80 per month
- Dining out: $100 per month
- Clothing: $70 per month
- Miscellaneous: $200
- Transfer to savings: $365
Total: $4,000
Step 3: Figure out how much cash to withdraw
Once you complete that last step, Lotich says that you just need to figure out how much cash to withdraw. As he sees it, when you’re first starting with envelope budgeting, you should try to pay cash for any category of purchases you can. However, it’s considerably more practical to pay certain bills online every month, such as your cell phone bill, your mortgage, your car insurance and your utility bills.
Using the example above, you would probably plan to pay the following bills online:
- Mortgage: $1,100 per month
- Car payment: $350 per month
- Credit card bills: $200 per month
- Insurance: $200 per month
- Utilities: $300 per month
- Transfer to savings: $365
Total: $2,515
From there, you would withdraw $1,485 to cover the following bills you could pay in cash:
- Groceries: $700 per month
- Gas: $150 per month
- Entertainment: $150 per month
- Personal care (makeup, toiletries, etc.): $35 per month
- Home supplies: $80 per month
- Dining out: $100 per month
- Clothing: $70 per month
- Miscellaneous: $200
Total: $1,485
Step 4: Stuff envelopes and spend funds from envelopes until it’s gone
Once you have the cash in hand for the month’s spending, you will physically put the cash into separate envelopes for each category. You will also label each envelope so you know what the cash inside is meant for, whether that’s “groceries,” “restaurants” or “transportation.”
Harrine Freeman, a financial expert and founder of H.E. Freeman Enterprise, says that envelope budgeting is easy to do from here — at least until it’s not. All you have to do is use the cash in each envelope for the appropriate purchases throughout the month, taking special care to make your money last.
If you don’t make your money last, then that’s where things get hairy. “When the envelope is empty, you cannot spend any more money in that category,” Freeman says.
For envelope budgeting to work, Lotich says that you have to quit spending in that category for the remainder of the month, versus spending the money anyway and letting it work itself out.
“If you want to go to the movies but realize your entertainment envelope is empty, it doesn’t mean you steal from your food envelope,” he says.” It means you get to stay home and read a book or play some board games with friends.”
Step 5: Repeat
Once you make it through your first month of envelope budgeting, you will probably want to tweak your categories so they work better for your spending. You may have found that some purchases are inconvenient to cover in cash, or perhaps you need a lot more money for groceries than you thought, resulting in you having to cut spending in another category.
Either way, you should expect to get better with each month you use envelope budgeting. Over time, you should become accustomed to how much you need to spend and how to cope when you run out of money before the month ends.
Pros and cons of the system
While the envelope budgeting method can be useful, consistency is key, Guy Birken says. If you struggle with taking consistent action with your finances, then it’s possible the envelope budgeting process could be a true non-starter in your life.
Either way, read over the pros and cons of envelope budgeting and ask yourself if you believe this budgeting method might help you get on track. If you believe you could save money and become more intentional by using cash instead of credit cards or debit cards, then it could be worth giving envelope budgeting a try.
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Learn more:
- The best budgeting apps to make your smartphone your wallet’s best friend
- Ways to save money on a tight budget
- Best money savings apps
