What is the envelope budget system?

Even in today’s digital age, many swear by the envelope budget system as a personal financial management system. Others, however, might say envelope budgeting is outdated among today’s roster of more modern banking and budgeting tools. Let’s take a closer look at how the envelope budget system works, what to keep in mind with this method and whether envelope budgeting might be helpful to you.

The envelope budget system, explained

What is the envelope system? The envelope budget system is a way to budget where cash is allocated into different envelopes, each labeled for a specific spending category like groceries, entertainment or bills. Many might like the envelope system for its simplicity as you can see the cash you have, in-hand. The physical act of removing cash from the envelope is a reminder that money is being spent, potentially making it easier to understand and stick to your budget.

Though this system is a tactile way to keep track of funds by having cash in hand, it may not be for everyone. How effective the envelope budgeting system proves to be will largely depend on your personal spending habits and lifestyle. Now, let’s learn how to set up an envelope budgeting system for you and take a closer look at some of its pros and cons.

How does envelope budgeting work?

Here’s a rundown of the essentials for a basic envelope budgeting system:

• Set spending categories: The envelope budgeting system hinges on the spending categories you choose. For many, the first step is to consider routine bills, such as rent or mortgage payments, groceries, utilities, entertainment and personal spending. You may also want to keep in mind any specific saving goals you have in mind, such as an emergency fund or perhaps a vacation.
• Label the envelopes: Next up, you’ll typically label each envelope the name of a spending category. Each envelope will hold the cash allocated for that category’s expenses. You may want to keep them all in a specific binder or folder to keep things organized.
• Allocate your budget: When distributing your income into the envelopes, you may want to prioritize essential categories in your budget, such as rent and groceries, before setting limits for the rest. It may be wise to review your spending history to determine realistic funds for each category.
• Spend accordingly: The crux of the envelope system is to only stick to what’s in each dedicated envelope for its designated purpose. For example, when grocery shopping, using only the cash from the “groceries” envelope.
• Track your spending: Keeping track of the cash in each envelope is key. If an envelope empties before the end of the month, it might signal to stop spending in that category. If this happens routinely, you might consider reassessing your budget allocation.
• Adjust as necessary: If you consistently have money left over in certain envelopes, you might want to consider reallocating those funds to other categories or savings. If you find yourself running out of necessary cash for essentials, you may want to increase its allocation. If you’re hitting spending limits, it might be wise to first consider whether it’s the envelope system’s function in preventing overspending or if you genuinely require a limit increase.

Cash stuffing vs. envelope budget system

“Cash stuffing” is another term often used interchangeably with the envelope budgeting system. Both methods use envelopes and cash categories to control and monitor spending. However, “cash stuffing” may sometimes be more of an envelope saving method focused on specific savings goals, such as a big purchase, whereas an envelope budgeting system typically covers areas of routine spending like your monthly grocery shopping.

Pros and cons of the envelope saving method

The envelope budget system, while effective for many, has its own set of potential pros and cons to consider. Let’s look at some of the upsides and potential pitfalls you might encounter with envelope budgeting:

Envelope budgeting advantages

• Clear spending limits: With your cash divided into envelopes, it might be easier to grasp how much money is available for each category and help prevent overspending.
• Increased financial awareness: Handling physical cash could potentially make you more mindful of your spending choices, which could lead to increased awareness of your finances across the board.
• Straightforward budgeting: The envelope budget system requires only your cash and some envelopes without any need for complex budgeting apps or software. This might appeal to some and make it more accessible to the less tech-savvy.
• Immediate feedback: The physical act of seeing cash decrease provides immediate feedback on spending. This may help with both tracking expenses and preventing impulse buying.

Envelope budgeting challenges

• Carrying cash risks: Having significant amounts of cash can potentially pose security risks and may be inconvenient compared to digital transactions.
• Inflexibility: Rigid budget categories could potentially make it more difficult to adapt to unexpected expenses or changes in financial circumstances.
• Potential for missed savings: Money in envelopes isn’t earning interest. The same funds, stored in a type of savings account, can earn returns on that money over time.

Is the envelope budgeting system right for you?

Whether the envelope budget system is suitable for you depends on a few things. It might be helpful to weigh the pros and cons above within the context of your personal financial situation, considering what your current challenges and goals are. Here’s a few factors that could be helpful to weigh when evaluating the envelope budget system for yourself:

• Spending habits: If you’re someone who struggles with tracking your expenses or staying mindful of your overall spending, the envelope system might reinforce better spending habits. One of the chief perks of envelope budgeting is its ability to make abstract numbers more real, potentially curbing impulse buys and improving your financial awareness.
• Financial discipline: A key to successful implementation of an envelope budget system is resisting the temptation to avoid borrowing from other envelopes for one category’s shortfall.
• Physical transactions: Are you comfortable carrying cash for your expenses? Or does this pose a potential security concern for you? Can you make do with reduced use of digital payments? A heavy reliance on physical currency may not be suitable for everyone.
• Opportunity cost: It may be helpful to reflect on the importance of earning interest on your savings. Money allocated in envelopes doesn’t earn returns of any sort — a potential consideration for long-term financial planning.

In summary

The envelope budget system is an old school way of keeping your money in check. By dividing your cash into envelopes earmarked for specific purposes, it’s supposed to be easier to track your spending and prevent impulse buys. But it’s not without its own challenges: From the responsibility of handling cash to the potential for better returns on your savings elsewhere, there’s a lot to consider before jumping into the envelope budget system. To determine whether envelope budgeting is right for you, consider your own personal financial situation and the unique pros and cons this classic budgeting method has to offer.