How a modernized envelope system can help your finances
The envelope system has been around for a long time. The idea behind it is really simple: When you get paid, you take cash and put it in envelopes that are labeled with things like “groceries,” “eating out,” and “hobbies .” Once the cash is gone, your budget for the month is expended and you wait until the next month to spend any more in that category. It’s a wonderfully simple and practical system and is advocated by the likes of Dave Ramsey.
Unfortunately, for many of us it is not practical. I’ve been essentially cashless since my senior year of high school when I got my first debit card. I’ve only continued this into adulthood where I’ve started using a credit card with a rewards system to get kickbacks on everyday spending. But even with my cashless spending, I’ve discovered a way to move the envelope system into the modern age and keep some of the biggest benefits of it. Here is what you need to do to set this up.
- Setup multiple savings accounts at your bank. Your checking account is where everything flows in and out of but the savings accounts are your new “envelopes.”
- Make one “envelope” your emergency fund. Once you do this, setup an automatic withdrawal from your checking account every month. This will feel like an expense as it pulls from your cash flow account. This is good because you need to understand that money is no longer available for everyday expenses, but in reality you are paying yourself and building a cushion into your finances.
- Make one “envelope” a large purchase savings account. Again, create a monthly automatic withdrawal from your checking account that will go into this account. It will feel like that money is gone because it has disappeared from your cash flow checking account where you do your day to spending and bill paying. This envelope is for large expenses that aren’t emergencies but that you can’t typically cover from your checking account. For example, this account could cover a new washer or a security deposit on a new apartment if you have to move. Essentially, it is one more layer of financial cushion and allows you to save your emergency fund for true emergencies (e.g. the loss of a job or medical expenses).
- Create additional accounts as needed to cover irregularly recurring and relatively large expenses. Those irregular expenses tend to be what make budgeting such a hassle. They tend to surprise you when they come up and they will shoot holes in the typical monthly budget. Creating savings account “envelopes” for these expenses will allow for an easy transfer of funds into your checking account when those expenses hit. For example, my wife has some irregular but not insignificant professional expenses. We budget for this by putting money every month into an “envelope” for her. That way when we need to pay those expenses it doesn’t shock our financial system and we haven’t already spent that money on Hot Pockets. Another example, we try to take an overnight trip every few months with our kids. These are not especially cheap since we have enough kids that we need two hotel rooms plus the expenses of eating out and fuel for the Family Truckster. To keep this from shocking the system, we put money every month in a “Travel Envelope” that funds our trips and vacations.
- Use traditional budgeting methods for regular, recurring expenses. Sorry, you don’t get off the hook here. Websites like Mint make this really easy to setup and automate. Just look at your monthly bills (utilities, cell phone, internet, etc) and create line items for each one. These tend to be pretty predictable as far as the amount is pretty consistent. You take this and combine it with your “Envelope” expenses (which is actually you saving and paying yourself) and ensure that on a monthly basis you are not spending more than you take in. The beauty of this though, is that a chunk of your “spending” is actually saving as you sock away money into your new digital envelopes to ensure you are prepared for future expenses.
What have you found to be an effective budgeting technique? Share your tips and stories in the comments!