Cash Envelope System: What Is It and How to Use It
If you’re a visually oriented person, you might benefit from the cash envelope system – a money management approach that aims to keep your spending in check.
The technique has been around for a while and is considered old-school; however, that doesn’t mean it’s outdated. It can be extremely powerful, especially if you’re somebody who equates money with physical objects (such as notes and coins) and tends to forget that those numbers in bank accounts are real, hard-earned money, too - as many of us do.
In this post, we discuss how the system works and how you can use it to manage your budget more effectively. Read on to learn more.
What Is a Cash Envelope System?
A cash envelope system is a budgeting approach that involves placing cash (notes and coins) into various color-coded envelopes based on your budget categories. The idea is to visualize how exactly you’re spending money and compare that to your financial goals.
For example, you might decide to allocate $400 for your monthly grocery bills, $200 for entertainment, and $500 for vehicle-related costs. The idea is to only use the cash that you place in these envelopes until the next budget cycle – usually a month.
For instance, if you get paid on March 30, then you would only use the money available in the envelopes until April 30, when you get to restart the process.
Naturally, how you categorize your spending depends on your financial priorities and how much money you aim to save. If you are following a tight envelope budget system or have high savings goals, you may need more envelopes.
How Cash Envelope Systems Work
Anyone can start a cash envelope wallet at any time. All you need are some envelopes and access to a cash machine.
In the following sections, we provide step-by-step guidance, showing you what you need to do.
Set a budget.
The first step is to set a budget for anything discretionary – things you choose to buy but can do without.
Don’t be too strict with yourself. Setting unrealistic goals and then failing to achieve them will only discourage you. But you shouldn’t be too generous, either – you want money left over at the end of the month for savings or investments.
To begin this process, check how much you’re spending overall right now. Take a look at your bank and credit card statements. You should be able to see what is going into your account (and what is flowing out of it) summarized in a monthly figure.
Now compare what you are spending to what you could be spending. If you’re spending $1,000 per month on unnecessary items, then you have plenty of wiggle room in your budget. However, if you are only spending on essentials, such as bills, housing, and food, then you might not be able to cut your budget much more.
Define your spending categories.
How you arrange your cash stuffing envelopes is very much up to you. However, you’ll want to cover everything if you can (otherwise, you might wind up spending more anyway).
Common categories include:
- Food (your grocery shopping for food you prepare in the home)
- Transport (your car, motorcycle, or bicycle expenses, and any public transport facilities you use)
- Entertainment (including dining out, going to the cinema, or spending money in bars)
- Beauty and hygiene products (such as makeup, sanitary towels, and so on)
- Household items (such as homeware, furniture, cleaning products, duvets, etc.)
- Pet (including food, toys, insurance, and vet bills)
- Miscellaneous (other items not included in the above categories)
Take a look at your bank statements to see how much money you’re spending in each of these categories. Doing this will give you a ballpark figure for where you stand right now. You may discover that you’re spending considerably more than you think on items like food, transport, and entertainment – and this could be holding you back.
Put limits on each category.
Next, drill down into the details of each category and ask yourself whether there is room to save. If you’re spending $1,000 per month on food, for instance, you can probably cut down. However, if you’re only spending $250, then opportunities for savings will be slim.
Putting limits on each category helps to make your financial goals specific and measurable. Choose a cap that makes sense for your circumstances. If you’re currently spending $1,000 on food because you’re buying lobster and caviar every month, you might try to reduce this to $500, eating beans, vegetables, and rice instead.
Get cash and fill your envelopes.
After you get paid for the month, the next step is to go to the ATM and withdraw all the money you’re allowed to spend according to your system.
Let’s say that you get paid $3,000 per month after taxes, and you allow yourself $1,500 for all your spending categories for that month.
Once you have $1,500, you then allocate cash in an envelope, according to your budgeting system.
For instance, you might allocate an all-cash budget as follows:
- $500 for transportation
- $250 for food
- $750 for personal spending and entertainment
As you can see, the amount of money you have available for each category is surprisingly small. Breaking it down shows you how much you really have to spend.
Once you have the money in each envelope, you’re not allowed to exceed spending in that category until the following month. For instance, if you go food shopping and you notice that your total spend is going to go over $250, you’ll need to put items back and choose something more affordable.
When applying the envelope system to your life, avoid the temptation to cheat. Don’t sneakily use a credit card to make a purchase, and tell yourself that you’ll save extra next month to make up for it. That rarely works.
The final step is to fine-tune the money envelope system as you see fit. Initially, it can be hard to calibrate. If you’re overzealous, you may find that you allocate too little money to each envelope to meet your basic requirements.
Being strict with yourself, though, has its advantages. If you only have a few dollars left in your food budget envelope, it forces you to get creative, seek out more affordable stores, and home-cook more. Likewise, you may find that you’re allocating too much cash to certain categories.
As you go through the process, your main goal should be to uncover your hidden spending habits. If you notice that cash in certain envelopes seems to disappear in the first week, then you immediately know where the problem lies.
Do the Envelopes Need To Be Physical?
In the olden days, envelopes had to be physical. There were no alternatives. However, thanks to software and improved computer technology, that’s no longer the case. You can now apply the cashless envelope method with various budgeting apps.
Before you opt for an app, though, you’ll want to consider whether this option is right for you. While some people won’t notice the difference, others may prefer using physical money. Numbers on a screen don’t seem as real.
How To Manage Fixed Expenses
There are two types of spending you engage in:
Discretionary spending includes things like clothes, vacations, and entertainment. Fixed spending, however, includes all of the items you don’t have much (or any) control over.
The envelope system doesn’t generally apply to fixed expenses. You’ll autopay most of these online or via your bank.
Fixed expenses include:
- Utility bills
- Insurance payments (including medical, car, and home)
- Pension payments
- Income taxes and other mandatory contributions
- Mortgage or rent
- Savings contributions
You’ll notice that in the above example, gross income was $3,000, but the amount available for discretionary spending was just $1,500. That’s because fixed expenses typically eat up around half the average person’s budget or more.
Generally, you’ll want to pay your fixed expenses soon after you receive your paycheck. This way, you can avoid the temptation to spend extra and miss payments as a result. Including these fixed costs in the envelope system is impractical and logistically challenging.
How To Succeed With a Cash Envelope System
While the cash envelope system sounds great on paper, how can you succeed using it personally?
Ultimately, it comes down to two things: your objective financial situation and your personality. Note that the latter determines whether the approach works for you or not only if you earn more money than is needed to cover bare necessities.
Now, if you do, the key to success is to raise your standards. Stop thinking of yourself as somebody who is always desperate for money and convince yourself that you’re better than that. Tell yourself you’re not going to accept living paycheck to paycheck anymore and that you want financial freedom.
Convince yourself that you won’t jeopardize your financial future or put yourself at risk of hardship with reckless spending.
Remember, when you build your investments, your passive income starts to grow. Within a few years, you’ll likely be able to supplement your regular paycheck with interest on your capital, such as stocks, bonds, or real estate you own.
When using the money envelope system, consider that future. Imagine yourself having already achieved it and bask in that positive emotion.
Where To Find Cash Envelopes
There are many places where you can find cash envelopes.
- Your local stationery store. This is often the simplest option. Most stores offer envelopes that are large enough to carry several hundreds of dollars.
- Online stores. Amazon, eBay, and Etsy all offer paper and plastic envelopes you could use as well. Here you’ll find plenty of colored options – great for those using a color scheme for their categories.
- Make them yourself. You can also make a good start down the road to financial prudence by making your cash envelopes yourself. All you need are some pieces of paper, scissors, and glue.
If you’re somebody who struggles to manage their finances, then the cash envelope method could help you. It’s not ideal for everyone, but it can be great for people who need to be able to see their money in order to treat it wisely.
How does the cash envelope system work?
Cash envelope systems work by setting limits for each budget category (groceries, entertainment, transport, etc.), assigning each category a (preferably differently colored) envelope, putting the sum designated for that category into the envelope, and then only spending the allocated amount for each spending category for the month.
What are the pros and cons of the envelope system?
The benefits of the cash envelope system include how easy it is to use, the fact that you can see your money (instead of juggling abstract sums in your mind when paying by card), and the ability to break down your spending into categories.
On the flip side, you’ll have to take out a large amount of cash from the ATM every month. Furthermore, the system is relatively inflexible since it doesn’t accommodate the fact you may need a larger sum for one spending category one month and less money in the same category the next month.
What is the 50-20-30 budget rule?
The 50-20-30 budget rule says that you should spend 50% of your monthly budget on essentials, 20% on savings, and 30% on everything else, after tax.
What is the envelope system good for?
The cash envelope system is good at showing you where you’re spending your money. People who use it quickly discover their “money sinks” – where they’re spending more than they should.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
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