What is Envelope Budgeting – Why the Envelope Budgeting System is so Effective?

By Richard Irons

The History of Envelope Budgeting

Back in the 'good old days' most Americans did not use banks as there was a great feeling of mistrust with these institutions and there was not any driving need for people to use banks during this time. Most people were paid with cash and paid cash for goods and services. Credit and debit cards had not yet arrived, thus forcing people to manage their spending with the use of on-hand cash. Eventually, many people began to organize their on-hand cash into a simple and easy-to-organize system. These households would divide their cash and place it into labeled envelopes. Each envelope would be labeled for a different category such as clothing, food, building materials, savings, etc. The envelope budgeting system was thus born and remained popular for decades. The system began to see a decline with the advent of credit and debit cards. As debt continues to surge in American households, the envelope method of budgeting is making a strong comeback.

What is Envelope Budgeting?

Envelope budgeting is a method where you take your income, convert it into cash, and then allocate your cash into different envelope categories. These envelopes are labeled for various categories of spending including required spending, such as your mortgage, groceries, and medical bills, and discretionary spending, such as eating out, entertainment, and shopping. As you divide your cash into envelopes, you can immediately see what on-hand cash you have to pay bills, make purchases, and contribute to your savings.

Sometimes an envelope does not contain enough on-hand cash to make a larger purchase. The envelope budgeting system really shines here as cash from another envelope could be taken to contribute to the envelope that is being used to make the purchase. For example, if you wanted to buy a new outfit and the clothing envelope was short $10, you could simply draw from another envelope to cover the difference. This method prevents the reliance on credit cards and ensures that the management of spending is kept in check, thus preventing debt.

Sample Envelope Budget

The chart below shows how the Envelope Budgeting system is set up and maintained

This is Jennifer's envelope budget plan. She has a monthly gross income of $2000.00. Jennifer has allocated her income into six envelopes, rent, car payment, groceries, entertainment, clothes, and savings.

In February, the groceries bill went up from $300 to $350. If the other spending categories remained the same, the overall budget is short by $50.00. Jennifer decided to take the available cash from the entertainment envelope to help fund the groceries envelope, thus reducing the entertainment envelope from $100.00 to $50.00. This allows Jennifer flexibility while staying within her overall budget. In March, Jennifer only spent $25.00 in her clothing envelope. This allowed her to free up $75.00. She decided to put $25.00 into savings and treat herself to some more entertainment by putting the remaining $50.00 into her entertainment budget. By April, Jennifer was able to accumulate $825.00 in total savings over a four month period and control her spending without going into debt. Though this is a simple chart on how envelope budgeting works it demonstrates how this method forces one to make intelligent decisions on how much to spend with what they have available.

Why Envelope Budgeting?

Envelope budgeting is simple to set up and manage if organized correctly. It may take some getting used to as this system is so unlike the traditional method of budgeting that most people are familiar with. The envelope budgeting method makes you pre-spend your income into various spending buckets. By allocating your known take-home income and dividing it into these buckets you see exactly how much you have to spend and when you can spend it.

By funding the different envelopes you see exactly how you can spend your money until your next pay period. This forces you to spend only what you can and rely less on paying bills with a credit card and incurring more debt.

Benefits of Envelope Budgeting

Below are several key benefits from utilizing the envelope budgeting method in your household:

• Pre-pay your upcoming bills by funding your bill envelope.
• Discover where & how you are spending and adjusting spending habits accordingly.
• Envelope budgeting is a well-organized spending management system – no assumptions, no guessing on where money is being spent and when to pay bills.
• Makes saving money easier by funding a savings envelope.
• Never overspend – your pre-allocated envelopes only lets you spend what you have. If an envelope does not have the funds needed to pay a bill or to make a purchase, money from another envelope can be transferred to ensure it can be paid off without overspending.
• Discipline – the envelope budgeting system teaches you to be on top of your financial situation. By eliminating guess work and assumptions you know where you are financially and can make intelligent decisions about purchasing decisions.

Starting an Envelope Budget

If your current financial situation is in crisis or needs an overhaul then dedicating yourself to the envelope budgeting system will give you a new perspective on how to manage your finances in an effective way. An online version of the envelope budgeting system may be a better solution if you like the convenience of debit and credit cards and online payments and transfers. One product that fully integrates the envelope budget system into a modern, online version is Mvelopes Personal. Mvelopes is completely online so you don't have to carry around physical envelopes stuffed with cash everywhere you go. Mvelopes has many great tools such as the capability to link to your financial institutions and automatically update your spending budget when you make a deposit or transaction.

The envelope money management system may seem overwhelming at first but if you put forth your best effort to making it work you will see how effective it can be. After you have set up your envelopes, managing the system becomes much easier. It may take a few tries but it will be well worth the time you invest in it. Best of luck on your journey to making a budget that works and remember the old saying "it is not how much you make but how much you spend."

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