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.

1. Develop a budget. Yes, I know for some of you that’s a four-letter word but at a bare minimum you need to at least know where the majority of your money is going. In Larry’s Burkett’s Complete Financial Guide for Young Couples: A Lifetime Approach to Spending, Saving and Investing he mentions that 10% of us are rich enough to not need a budget, 10% of us actually have a budget and that 80% of us do not. Can you answer these questions within 5% accuracy?
   • How much cash do you withdraw per month from ATMs and where does it go?
   • How much do spending eating out per month? Could you save money when you eat out?
   • Do you balance your bank account monthly? If not, convince me that there aren’t merchants who mistakenly overcharged you for a good or service.
   • How much do you spend on your car and car service per month? For most people this is the second-biggest expense next to paying a mortgage or rent.
2. Decide which items in your spending are a want versus a need. All of us have the same basic needs of shelter, food and clothing. Other obvious needs include insurance (health, auto, etc.), basic utilities such as electricity and water as well as various household convenience items like a microwave and dishwasher. However, what about that Netflix service at $20/month? Or playing golf twice a week in the summer? Or maybe taking a cruise every year? At your previous income level these items could be purchased without much of an impact to the household budget. Now that your income is reduced do you need to play golf so often? Could you take up a cheaper or nearly free form of exercise like jogging, tennis or basketball? If Netflix costs you $240/year could you get similar movies from the library for free? Most libraries now will let you reserve DVDs online through their website. Once you’ve weeded out all the extraneous wants I would estimate many people can save 10 – 30% on their spending. Keep in mind that these may not be permanent spending cuts. They might be only temporary cuts for a couple months or years depending on your situation.
3. Can you lower your grocery bill? You don’t need to take it to the extreme like this couple, but you could start buying some generic brand name items. You can see some major savings buying generic items as detailed here.
4. Are you “car poor”? Noted personal finance expert Dave Ramsey recommends that your car’s value should not be more than 50% of your household income. Let’s suppose your annual household income is $70,000. You drive a $20,000 minivan and your husband has a $25,000 truck. The total value of these automobiles is $45,000 which is 64% of your household annual income. This is a problem. Unless you and the family are living in one of those vehicles this is too much money tied up in the world’s worst depreciating asset. If you can get over the whole car-as-a-status symbol thing, you’ll save tons of money on car spending.
5. Call your bank and see which loans or credit cards they will lower for you. First of all, banks absolutely will not offer this to you out of the clear, blue sky. You need to light a fire under their seat and threaten to leave the loan with a competing lower rate. Or just ask them to lower it like my brother, Dad and I all did here. You will be amazed at how responsive the bank customer service representative is when she realizes that her employer may lose your business.
6. Pay cash. It is amazing how much you appreciate your purchases when you need to save up for them. The reason credit card companies (and casinos) are billion-dollar enterprises is because they have successfully removed the emotion from spending. Anyone can sign the credit card receipt for pay for a $45 dinner out with the family and think nothing of it. But when actual green cash is involved coming out of your wallet bill by bill somehow you are more aware of this spending. And it’s more painful for you, thus reducing your spending.

Hopefully your major pay cut will be temporarily short term or it was a pay cut chosen by you on your terms. If not, I hope the tips above can provide you some ammunition in battling a reduced household budget.