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The Benefits of the Envelope Budget System

August 20th, 2007 · No Comments

What if I gave you a bowl of skittles and told you that you could eat as many as you wanted? Then right before you finished the skittles I mentioned you are going to need to save 20 green ones or else. Would you be frustrated that I waited until the bowl was nearly cleaned out before you found out you will need those green ones? That is exactly how many of us run our checking accounts. Plunk down your paycheck in the account (skittles in the bowl) and then keep spending and spending and spending until the account is nearly empty and then-OOPS!-the car needs a $400 repair and we only have $58 in the account (you didn’t save enough green skittles). Or put another way…..plan for your spending!

The envelope budget system works like this: take about five or six envelopes and label them for your discretionary spending accounts. This would include groceries, eating out, vacations, entertainment, household items and gift spending. I would not recommend setting up envelopes for your utilities or house payment since you do not have much control in affecting those monthly amounts. Plus, it is not realistic or convenient to pay your electric bill in cash. Next, go through these discretionary categories and break down how much you need to put into each envelope per month (or per paycheck).

Sample paycheck of $2000 take-home pay per month:

  • Approximately $1200 per month of the paycheck goes to the mortgage, utilities and loans. This leaves $800 for the envelopes
  • $400 per month for groceries
  • $50 per month for gifts (weddings, birthdays, etc.)
  • $75 per month for eating out (this could be merged with the groceries account if you wish)
  • $75 per month for vacation
  • $100 per month for household items (home improvement items, landscaping, home repairs, etc.)
  • $100 per month for clothing

Here’s how it works. Every paycheck you go to the ATM and withdraw $400 in cash (and drive home very carefully!) and do that twice per month to get the $800 in the above example. Once you get home you deposit half of the amounts above (example above was monthly amounts) into each of the envelopes. Then as you spend money during the week you take it from each envelope. Each one acts as sort of its own bank account. I’d recommend recording the amount you removed from the envelope on the envelope itself. Two things will begin to happen to you over time:

  1. You will control your money. Not the other way around. Who wants your money (how much or little you have) to control you? Not me.
  2. Instead of having too much month left at the end of your paycheck, you will have plenty of your paycheck left over at the end of each month.

A perfect example of the envelope budget system in action occurred to me this weekend while replacing our broken mailbox post near the street. The “household items” envelope at the time had about $60 in it. I took that cash and headed to the hardware store. As luck would have it, the mailbox I found and liked cost $52. That left me with $8 to put back in the “household items” envelope. The way most people do it would be to buy any mailbox regardless of what’s in their bank account or even worse put it on a credit card. My envelope system sent me home with leftover cash in my pocket and control of my finances (only having $60 for this category forced me to keep in within the limit).

My wife and I did the envelope system right after we were married in 1995 and now I’m pleased that we’re back on the system. Another benefit of the envelope system is that you pay cash for things. Paying cash for big ticket items has a bit of a sting to it. Imagine buying a new $900 refrigerator and shelling out nine Benjamins one by one by one to the Best Buy salesman. Believe me…it’s painful watching that cash go out of our wallet.

Another benefit of the envelope budget system is that you enjoy the items for which you’ve saved your money. Most consumers charge their Disney trip and then spend months, interest and frustration paying it off later. With this system you are depositing $100 per month into an envelope saving for that vacation. Imagine how much more fun Mickey Mouse or Space Mountain become when you know the trip was paid for before you ever entered the park or hopped on that airplane.

One final benefit of the envelope system is that it forces you to have a front-row view of where your spending is going. Watching one envelope continue to get cleaned out or seeing another build up over time reminds you of your spending habits. For us personally, the grocery envelope gets tattered and worn in about two months of use, but the “Christmas” envelope is still fresh and crisp like the bills in it.

Bottom line: the envelope budget system makes your money work for you, not the reverse.

Tags: Budgeting · Money

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