How Does the Envelope Budgeting System Work?

It’s a cash-based method

Making a personal budget is important for managing money. The envelope budgeting system is one option for tracking spending each month. It involves dividing cash into different envelopes that represent individual spending categories. This approach can also be adapted for use with mobile budgeting apps.

Key Takeaways

  • The envelope budgeting system is designed for people who primarily spend cash.
  • It is intended to control their spending each month by limiting them to using only what’s available in each envelope.
  • It can be used alongside other budgeting methods, such as zero-based budgeting.
  • Making an envelope budget starts with estimating monthly income and expenses.

Understanding Envelope Budgeting

A personal budget is a record-keeping system for income and expenses. According to a 2021 survey, approximately 80% of Americans say they keep a budget each month, and 88% say everyone should budget regularly. There are different ways to make a budget, including zero-based budgeting and annual budgeting.

The envelope budgeting system uses a cash-based approach to help people who struggle with sticking to a budget to be more mindful of—and deliberate with—their spending. You begin with multiple envelopes, each of which represents a different budget category. You then assign a certain amount of cash to each one, based on how much you anticipate spending in that category for the month. Once the envelope is empty of cash, you may no longer spend any more money in that category until your new budget period begins.

Cash envelope budgeting can be adapted for use with mobile budgeting apps that allow you to create digital envelopes for tracking debit card spending.

How the Envelope Budgeting System Works

The envelope budgeting system isn’t complicated. There are, however, some specific steps to follow for setting it up.

Step 1: Add Up Monthly Income

Before you can begin using the envelope method to budget, you need to know your monthly income. This includes all the money that you expect to bring in for the month. Your income sources may include:

  • Paychecks from a nine-to-five job
  • Earnings from a part-time job or second job
  • Side hustle earnings
  • Investment income
  • Alimony or child support payments, if applicable
  • Government benefits, if applicable
  • Stimulus payments or advance tax credit payments

You may also include any one-time sources of income that you expect to receive for the month, such as tax refunds or rebates.

If you have irregular income from self-employment, you can establish a baseline average income by adding up your total earnings for the past year, then dividing the amount by 12.

Step 2: Set Budget Categories

The next step with envelope budgeting is choosing which categories to put in your budget. These may include:

  • Groceries
  • Auto fuel and oil
  • Clothing
  • Dining out
  • Entertainment
  • Personal care
  • Pet care
  • Household items
  • Gifts

Expenses for housing, utilities, insurance, and debt repayment are typically not included in envelope budgeting because they represent the fixed part of your budget—expenses that don’t change much or at all from month to month. You may pay these bills electronically via ACH (Automated Clearing House) transfer, with your credit or debit card, or by writing a paper check. Your cash envelopes should represent categories in which what you spend changes each month.

Reviewing your bank statements for the past three to six months can give you an idea of the categories in which you tend to spend the most or least, and when.

Step 3: Assign Budget Amounts to Each Envelope

Once you’ve determined your income and chosen your budget categories, you’ll need to decide how much money to allocate to each one. For example, say you have $1,500 to budget for cash spending each month. Here’s what an example envelope budget might look like, based on average consumer expenditures for 2020:

  • Groceries—$412
  • Auto fuel and oil—$131
  • Clothing—$120
  • Dining out—$198
  • Entertainment—$243
  • Personal care—$54
  • Miscellaneous—$76

Your total spending would come to $1,234. You would have $266 left that you could budget to cash envelopes. You might allocate some of that money to an envelope for pet care, some for an envelope for child-related expenses if you have kids, and the rest toward gifts or charity.

Step 4: Spend the Cash in Each Envelope

Once cash has been assigned to each envelope, put your budget to work by spending it to cover expenses. Each time that you take cash from the envelope, subtract the amount from your total. For example, if you start off with $100 in your gas envelope and pay $25 at the pump, then jot that down on the back of the envelope. This allows you to keep a running tab of how much you have left to spend in each envelope.

The key to making the envelope budgeting system work is spending only the money that you have on hand. Say you have $412 assigned to your grocery envelope. If that’s your entire budget amount for the month, then you would be able to spend about $95 per week ($412 × 12 months ÷ 52 weeks). Once that money is gone, you wouldn’t be able to spend anything else until the new budget month begins.

You could take cash from another envelope, but that might leave you with a shortfall in another budget category. For that reason, using the envelope budgeting system requires a certain amount of discipline to avoid overspending.

If you have money left over in your cash envelopes at the end of the month, you could add it to a high-yield savings account or use it to make an extra payment toward debt.

Pros and Cons of Envelope Budgeting

Understanding what’s good—and potentially not so good—about envelope budgeting can help you decide if it’s right for you.

  • Allows granular insight into monthly spending, avoiding overspending

  • Encourages the habit of tracking spending

  • Helps to save money

  • More time-consuming and tedious than other methods

  • May be easy to forget an expense

  • Not as convenient or secure as using a debit or credit card for certain purchases

When deciding whether to use cash envelope budgeting, consider your current spending habits. If you’re already disciplined about tracking your expenses, switching to envelopes may not be too difficult. Also, consider where you tend to spend the most and whether paying in cash instead of using a debit or credit card makes sense.

For example, you could pay with cash when dining out. However, if you were to use a dining rewards credit card instead, you could earn some points or cash back on that expense, which could save you money, assuming that you pay your balance in full each month to avoid interest charges.

What is envelope budgeting?

The envelope budgeting system involves assigning spending categories to individual envelopes. Each one is allotted a certain amount of cash, which is then used to cover spending for that category.

How do you set up a budget envelope?

First, choose the spending category for which the envelope will be used, then decide how much money to put in it. Write the starting cash total on the outside and subtract each purchase amount from it to keep a running total of how much you have left for the month.

How much money should I put in each envelope?

There’s no set amount to assign. Rather, you should choose a dollar amount that reflects what you typically spend in that category each month. Thus, if you spend $100 a week on groceries, the envelope should have $400–$450 in it.

The Bottom Line

The envelope budgeting system is a cash-oriented approach to thinking of budgeting, though you can use virtual envelopes instead of real ones. It makes budgeting—and visualizing how you spend money—very tangible, but it can also be tedious. And If you use real cash, you can lose the rewards and security of using a credit or debit card.

Article Sources
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  1. “Americans Are Budgeting More Than Ever.”

  2. U.S. Department of Labor, Bureau of Labor Statistics. “Consumer Expenditures — 2020,” Pages 5–6.