Envelope budgeting is a simple, systematic way of saving to pay bills while maintaining a personal budget, and it's being implemented in some very good personal budgeting software these days.
How Envelope Budgeting Works
This budget method started back when bills were paid with cash and people could separate physical cash bills into different envelopes, each representing a different purpose. Even if you no longer use cash to pay bills, the principle still works and can be applied using today's financial technology. For this example, we'll use a monthly time frame, but you can use weekly or any period that works for you.
- To use envelope budgeting, first establish spending categories for your budget and then set spending limits for the categories. The total amount for the spending categories must not exceed your monthly income.
- Using one envelope per spending category, write the name of each category and the monthly budgeted amount on the envelopes. If you are paid weekly or bimonthly, divide the total monthly amount for each category by the number of pay periods you have and record that number on the envelope as well.
- For this example, assume you cash a paycheck, although most people have their paychecks deposited directly. Cash your paycheck and put the allocated amount for each budgeted category into the respective envelope.
A very simple example would be a weekly paycheck netting $500 with these expenses:
- $100 going into the grocery budget envelope
- $200 to the rent budget envelope
- $70 to the gas and auto maintenance budget envelope
- $30 to the utilities budget envelope
- $70 to the personal care and clothing envelope
- $30 to the savings budget envelope
- When you go shopping or pay a bill, take the money for the payment from the appropriate envelope.
The strength of envelope budgeting is that it forces you to stay in touch with spending habits because once the envelope is empty, you can't spend from that category until the envelope is replenished by the next paycheck.
Envelope Budgeting With Financial Software
With today's direct deposit of paychecks, electronically transferring funds, debit cards, credit cards and checks, traditional envelope budgeting is obsolete. However, personal finance or budgeting software that is built around envelope budgeting principles lets you use convenient financial transaction methods while using envelope budgeting discipline.
Envelope budgeting software often uses virtual envelopes or other graphics to represent budget categories and to show spending activity and balances for each category. When income is recorded, the software distributes a portion to each "envelope." When a purchase is made, tell the software which spending categories to use and the software deducts the "money" from the envelopes.
If you use a credit card or similar payment method, the software transfers the total expense to yet another envelope to hold the "cash" until the credit card bill is paid. Bills that are paid directly and not put on a credit card (a car payment, for example) cause the software to remove payment amount from the appropriate envelope.