The envelope budgeting method is a simple, systematic way of saving money and paying bills. The method helps you set aside what you need for bills while maintaining a personal budget. It is a popular budgeting system and can be implemented with personal finance software as well.
How Envelope Budgeting Works
The envelope budgeting system divides your income into different spending categories—bills, groceries, gas, and so on. Once you've decided how much you should spend on each category, you'll take that amount in cash and place it into an envelope. Then, only spend what's available in that envelope for that category's bills or purchases. The aim is to prevent you from overspending by limiting what is available to spend.
Even if you no longer use cash to pay bills, the principle still works and can be applied using software or other financial technology.
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 next paycheck replenishes the envelope.
Step 1. Establish Categories and Limits
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.
To understand what categories might be useful for your budget, consider where your money goes. Try to list your common expenditures so you can group them effectively. For example, your categories may include:
- Health and grooming
- Dining out
- Household items
- Pet care
- Children's items
Tailor your categories to your specific situation. Make as many categories as you need, but not so many as to be overwhelming.
Don't forget to include irregular expenses, such as taxes, insurance, or gifts, and a savings category.
To discover what a reasonable monthly limit might be for each category, check your recent banking statements or receipts to get an idea of your usual costs. You can use that number or, if you're trying to cut back, use a slightly smaller figure.
Step 2. Label Each Envelope
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 in each month and record that figure on the envelope as well. That will help you put the right amount from each paycheck into the envelope.
Step 3. Separate Funds
For this example, assume you receive a paycheck for $500. Cash your paycheck and put the allocated amount for each budgeted category into the respective envelope. A simple example might be divided like so:
- $100 in the grocery budget envelope
- $200 in the rent budget envelope
- $70 in the gas and auto maintenance budget envelope
- $30 in the utility budget envelope
- $70 in the personal care and clothing envelope
- $30 in the savings budget envelope
Each time you are paid, add that check's earnings to each cash envelope according to your established budget.
Step 4. Spend From the Envelopes
When you go shopping or pay a bill, take the money for the payment from the appropriate envelope. If you are paying a bill in person, carry the envelope with you. Likewise, if you are going grocery shopping, bring your grocery envelope.
If you send all of the money in one of your envelopes, do not pull cash from another envelope in order to continue spending. If you do, you'll be short for that category.
At the end of the month, if you have money left over in any of your envelopes, you can either keep it in that envelope for the next month's spending or remove it and add it to savings or your emergency fund. Budgeting in this way can help you reach a savings goal, which in turn can help you keep your budget on track.
Envelope Budgeting With Financial Software
With direct deposit for paychecks, electronic funds transfer, debit cards, credit cards, and checks, cash envelope budgeting may seem obsolete.
However, with personal finance or budgeting software that is built around envelope budgeting principles, you can use convenient financial transaction methods while still maintaining the discipline of envelope budgeting.
Envelope budgeting software such as You Need a Budget uses virtual "envelopes" 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."
Bills that are paid directly cause the software to remove the payment amount from the appropriate envelope. If you use a credit card as a payment method, the software can set aside that amount in a credit card payment "envelope" or category to be used when you pay the credit card bill.