Setting up a budget is an important part of managing your money. You can figure out how much you earn, record all your major monthly expenses, and then make a plan for how to allocate your after-tax income to ensure those bills are covered—including an emergency fund.
“A budget ensures you’re going to be able to do fun things that you want to do, while working toward more serious financial goals,” says Julie Everett, a certified financial planner with Financial Finesse.
But the hard part might be sticking to the budget you make. And if you regularly overspend, you might not reach those financial goals you’ve set. The envelope budgeting system is one way to track your money each month, and it may help you curb overspending because it limits what you have available.
The envelope budgeting method is a budgeting system that was popularized by personal finance author Dave Ramsey. The method involves dividing your take-home pay into spending categories (e.g., rent, utilities, et cetera), labeling an envelope for each category, and putting the cash you plan to spend into the envelopes. When you need to pay for something within one of those categories, you’ll take money from the appropriate envelope to cover that expense.
“The idea is that once the envelope is empty, you don’t spend any more in that category until it’s time to replenish the next month,” says Amy Lins, vice president of enterprise learning at Money Management International, a nonprofit credit counseling agency.
This budgeting system may help regulate your spending because cash users are more likely to form an emotional connection to their money.
You’ll start by checking how much after-tax money you bring home each month, figuring out where you typically spend money, and allocating the appropriate amount to cover each expense category.
The spending categories are your important expenses that need to be covered each month, and can also include additional “fun” categories. So they include things like groceries, dining out, gasoline, a vacation fund, and personal needs like haircuts and clothing. Because housing costs, utilities, insurance, and debt repayments are typically fixed expenses, they won’t be included in the envelope categories.
If you want a guideline, you can split your money using the “50/30/10” rule. You’d spend 50% of your take-home pay on needs like housing and utilities, 30% on wants like travel and entertainment, and 20% on debt repayment and savings. Let’s say you earn $55,000 a year from a job and bring home $3,400 a month. Your spending would be divided like so:
In general, expenses like your rent, utilities, and other debts are not included in this budgeting method.
Want to set up the envelope budgeting system for yourself? You can either use cash and actual paper envelopes—or you can adopt a digital approach using spreadsheets and apps like Goodbudget.
Here are the steps you can follow.
Look through your bank statements to figure out how much you take home each month after taxes and payroll deductions. Include all sources of income, such as earnings from a job, side hustle, or investments.
If your income varies every month, then calculate the average by adding up your total earnings for the past year and dividing the amount by 12. In our example above, you bring home $3,400 a month.
When you’re defining your variable expenses, check your most recent credit card or bank statements to get an accurate calculation. Everyone’s categories will be different, but the main ones usually include:
Check whether each expense is necessary. If there are any luxury spending categories, you’ll need to decide which ones you can afford to keep—or cut. “I see a lot of people trim their subscriptions at this point,” Everett says. Going back to our example from before, your total monthly spend is $2,380 each month on fixed needs ($1,700), debt repayment, and savings ($680). That leaves $1,020 ($3,400 minus $2,380) for you to spread across the envelope categories.
Now that you’ve determined your take-home pay, envelope categories, and how much you can spend, you’ll decide how much money to allocate to each category. Here’s an example of how you might divide your remaining $1,020:
Each pay period, you’ll take out cash—which is $1,020 in our example—and divide it among your envelopes. Write the starting total on the envelope, and list each purchase every time you spend money. Keep a running total of how much cash you have left in each envelope for the month. Then, review your budget regularly.
“If you spend less than budgeted one month, leave that money in the account for the month when you need a little more,” Lins says. “The challenges arise when you get busy, don’t write it down, put it out of sight and out of mind, or don’t develop the habit of doing a budget check-up.”
If you regularly run out of money in an envelope that’s important to you, Everett says, it may be time to reassess what you’ve budgeted for the category. For instance, you might shift money from your “entertainment” envelope and add it to your “dining out” envelope based on your priorities.
So is this budgeting approach right for you? It all depends on how you spend and manage money—and whether this strategy aligns well with that. Ultimately, understanding the pros and cons of the envelope budgeting system can help you decide whether you want to try this approach.
The envelope budgeting system can be a good fit for people who want to track their spending and need help staying within their monthly allowance. Here are some other upsides:
The envelope budgeting system comes with a few drawbacks—but they’re all related to using cash. If you want the benefits and structure of the envelope system but don’t want to carry around cash, consider using a spreadsheet or budgeting app.
The envelope budgeting system is a tangible, cash-based approach that may help you track your spending and limit your purchases. But because cash is vulnerable to theft and lacks the benefits of credit cards, you can also use virtual envelopes or a spreadsheet for a cashless approach to this method. You could also look into other budgeting strategies such as pay-yourself-first or zero-based budget. If you’re still struggling with overspending, you might benefit from talking with a credit counselor at a nonprofit agency, such as the National Foundation for Credit Counseling. They can help you find a budgeting approach that works for you and your financial situation.
Grab four quarters from your car’s ashtray and make a quick trip to the discount store and you could immediately begin a budgeting system that can revolutionize your financial fortunes and keep you out of debt.
Even better, you can start for FREE with a few sheets of stationary paper and a staple gun.
Sound too good to be true?
It’s grandma’s “envelope system of household budgeting” though you may never have heard if from Grandma. It really was made famous (and a lot more popular) by finance guru and radio talk show host Dave Ramsey. All you need to get started are some ordinary envelopes, either store bought or homemade.
Oh, you also need to mix in some financial discipline. You’ll definitely need that. Lots of it, actually. It’s the whole point of this exercise. Envelopes are simply a means to that end.
The envelope system is based on the whole psychology of people spending less when using cash instead of plastic. You are far more restrained in your spending when you pull money (not plastic) out of your wallet.
That’s one of the biggest benefits to stuffing cash into envelopes for budgeting purposes. It forces you to think twice … and maybe the second thought is that you don’t really need that item, after all.
You should know that the envelope system is far from a slam dunk strategy. In a society that is rapidly moving to cashless commerce, it might not be practical to stuff currency into envelopes. Who really wants to carry a wad of cash anyway? There are apps and other online tools that can accomplish the same objectives.
Still, the budgeting envelope system is one way to take (disciplined) control of your finances. Here’s a closer look at how it works:
The envelope system is a way to force yourself to accurately budget discretionary expenses every month. It demands honesty, discipline and commitment, but the reward is that you gain control of your finances.
Let’s start with your salary. Assume you get paid twice a month with a total take-home income of $3,000 during that period.
Then you budget $500 a month for groceries, or $250 per paycheck. When the month’s first paycheck is deposited, go to the bank and withdraw $250. Put that cash in an envelope and label it “Groceries.’’
Every time you purchase “groceries” it must be with money from that envelope and only that envelope. If you go to the grocery store and realize you don’t have your envelope, you don’t whip out the credit card or debit card for payment. You go home and get the “Groceries” envelope. Yes, really. That is discipline.
Remember, you can ONLY buy groceries with the cash in that envelope. So, if your bill hits $251, guess what? You must put something back. There’s no wiggle room — NONE!
Once the money is gone from your “Groceries” envelope, you’re done until the next paycheck arrives. This system is how you find out how accurately you budget and how much money you really are spending on … groceries!
When you get your second paycheck of the month, withdraw another $250 and refill the “Groceries” envelope.
Next step is to identify all your monthly discretionary expense categories and make an envelope for each of them. Ramsey suggests using different colors for each envelope to avoid any confusion, but as long you label everything, you should be all right.
Your other bills – mortgage/rent, car payment, cell phone charges, cable television charges, electric bill and others — are fixed expenses. They can be put on autopay from your checking account because these expenses are unchanged and you don’t need constant bank trips to drain your checking account for every fixed expense.
So, what can go wrong? Plenty!
Not everyone spending money in your household is going to have the same discipline you will show with the envelope system, so here are some quick fixes to keep the system working.
» Learn More: Do Dave Ramsey’s Baby Steps Actually Work?
Sounds logical. Maybe your husband or wife will make a quick grocery run after work — when you have the Grocery envelope. The fix: When you begin with your initial $250 grocery allotment, put $200 in an envelope for you and $50 in an envelope for your spouse (or go $125 and $125 … whatever works).
This is like dieting. No one can make you stick to a diet or a budget. It requires planning and self-discipline. You should learn quickly about your weaknesses in the budgeting process and adjust accordingly. The fix: Only make purchases when you have the right envelope in your hand. If you can’t stick to the all-cash envelope system, leave the other envelopes (and your debit/credit cards) at home. Don’t stray from your purchasing plans and the overall budget.
Well, if you have realistically projected the needs for all the envelopes, you win! The probably won’t happen for a few months, but the envelope system should change your spending habits — if you have discipline. If not, what’s the point? The fix: Keep a miscellaneous spending envelope. That can cover an unexpected event like a birthday present or an overrun in another category. Money always will be limited, so self-control and discipline are non-negotiable items.
The envelope system can still work, but in a different way. Remember, the idea behind carrying limited physical cash is simply to control how much you spend, almost utilizing it as a quick visual. The fix: Keep money in your bank account, but list expenses on your envelope. DO NOT spend more than what you allocated. It might require even more willpower, but the principle remains the same. Once you hit budget for that month, you’re done. There’s no more money to spend.
Using the envelope system carries a major assumption — that you already have enough money in your bank account to divide cash into envelopes when the month begins.
But according to the Harris Poll, 78% of Americans are living paycheck to paycheck, including almost one in 10 who earn more than $100,000 annually. More than half of Americans (56%) save $100 or less per month.
Meanwhile, according to a Bankrate survey, 57% of Americans don’t have enough cash to cover an unexpected expense of $500.
Obviously, if you are using this week’s paycheck to settle last week’s spending, you aren’t getting ahead. Here are some ways to put yourself in better position for using the envelope system:
Spending Doesn’t Equal Happiness — Making more money to buy more stuff doesn’t equal happiness, according to Harvard University professor Daniel Gilbert. He said a certain level of income can achieve comfort, somewhere in the per capita range of $50,000 to $75,000. After that, Gilbert said higher-income people are generally wasteful with their spending. He said people are happiest when their minds are engaged — or even when they’re giving money away instead of spending it on themselves.
When we splurge on something — say, the latest electronic gizmo or a really lavish dinner with friends — it can bring a momentary burst of happiness. Then it mostly gets forgotten. But if we don’t have enough money to feel secure or make ends meet, a splurge becomes a sensation to be remembered.
Find Fun Activities That Don’t Cost Money — Do you love to read? Go on hikes? Visit a park? Play board games? Watch television? Well then, do those things! They’re a lot better for your wallet than a big-time restaurant or theme park.
You derive pleasure from doing things, not buying things. Yes, there are shop-a-holics and people who swear by a little retail therapy. But those feelings are generally short-lived. If money is tight, there will be regret. Enjoy the things you already have. Or become an expert in free activities.
Don’t Get Sucked in by Advertising — Almost everything in our culture can confuse the definitions of needs and wants. At every turn, we are lured by products we don’t need. We question our lifestyle. We are tempted to try that new pricy restaurant. We might secretly want to spend more than we have on some frivolous item, but it’s not what we need. Know the difference.
Get Happy by Saving Money — There are few things more depressing than having a poor financial outlook. Worry leads to panic, which sometimes leads to a meltdown. It’s far more efficient to organize your money and use it efficiently, eliminating waste (and worry) from your life. You might find that the absence of financial worry also means the reduction of stress in your life.
Drastically Cut Your Expenses — What happens if you cut out everything that isn’t essential? Move to a smaller place. Get a less expensive car. Cut out your cable bill, your cell phone, your internet. Eat at home. Find some hobbies that are free.
How can anyone live like that?
Well, give it a try. You might like it. If you don’t? You can always add back those things that have been cut. What have you lost? Nothing. And you’ve gained knowledge.
Welcome to the 21st century, the land of PayPal, ApplePay, credit cards, debit cards and … cash?
Not so fast on that last one.
Transactions these days are largely handled with a quick swipe or the punching of a few buttons on your mobile device, not reaching for your wallet and sifting through a wad of bills. Let’s face it, many people don’t feel comfortable carrying cash, especially the millennials who grew up in a largely cash-less society.
So what to do if you choose to employ the envelope system?
Obviously, there have been skilled pickpockets as long as money has existed, so keeping money secure is not a new issue.
Some more common questions about the envelope system:
And the answer is … all the money that you will need to make the “budgeted” purchase. The envelope system forces you to examine purchases, so a little thought and pre-planning will enable you to bring the right amount. Again, this is about deliberate purchases, not impulse buying.
Ah, here’s a fun one. If you come in under budget, it’s OK to celebrate and reward yourself … within reason. Why not have a fancy dinner or a nice latte? Rewards can keep you extra motivated. You can also roll over the money to next month, so you could have an extra-large grocery budget. That’s another reason to celebrate.
This is important. You shouldn’t “borrow’’ from the other envelopes. That defeats the purpose of this system. Here’s a novel solution: Suffer a bit.
The envelope system’s purpose is to control your spending and help you stick to your budget. If one envelope is getting low, you might need to cut something back — or do without – until the next paycheck.
It’s possible you have miscalculated how much is actually needed per month for certain items, so you are allowed to adjust your figures, but only once. Don’t get in the habit of shifting them around.
There are modern alternatives to using cash with the envelope system, but there’s research on how using cash actually makes you spend less.
According to Avni Shah, a professor at the University of Toronto Scarborough and Rotman School of Management, paying with cash triggers different pain sensors in the brain. Using cash encourages consumers to shop around, look for deals and spend less. Meanwhile, swiping a card encourages consumers to spend more.
Shah, in accord with researchers from Duke University and the University of North Carolina during a 2016 study, concluded that credit/debit cards are excellent for convenience but they make consumers less connected to purchases.
“That convenience may come at a price,’’ Shah said in a University of Toronto Scarborough article. “You feel something when you physically part with your money, and there are different levels of pain depending on the type of payment. Something tangible like cash will feel more painful to part with than paying by (check), which will feel more painful than paying by card and so on.’’
There are many other studies that back up Shah’s findings.
A 2012 study by University of Utah professor Promothesh Chatterjee and University of South Carolina professor Randall L. Rose pointed out that consumers who use credit tend to focus on the product’s benefits instead of its costs.
In 2001, Massachusetts Institute of Technology professors Drazan Prelec and Duncan Simester randomly selected participants who were offered the chance to purchase highly sought tickets to a professional basketball game that had just sold out. Some were told to pay by credit card and others were told they had to pay cash. On average, those who paid by credit card were willing to spent twice as much as those who paid with cash.
Or as Cornell University economics professor Robert Frank once said in a National Public Radio interview: “Parting with it (cash) is just a more vivid sensation than the abstract act of signing a pledge to pay sometime later in the future.’’
Like anything, there are pros and cons to the envelope system.
Pros: It forces you into a disciplined budgeting system. It requires pre-planning before shopping excursions, instead of going to a store blindly and falling victim to impulse purchases. When you’re out of cash in the envelope, that’s it. You can’t overspend. Plus, you avoid the overdraft and fee penalties associated with careless card swiping.
Cons: Carrying cash is not a practical system for some consumers. The use of credit/debit cards give an automatic and exact system for tracking purchases, which can’t be replicated by using cash. Cards also allow you to accrue points and have cash-back options with purchases, a great option if the disciplined spending is utilized.
The guiding principle of the envelope system — setting aside a specific sum for items such as groceries — can be replicated without having to carry cash.
Here are some alternatives:
The Clip System: OK, this isn’t very modern or much different than the envelope system, but it’s a bit less clunky. Instead of envelopes, you use clips, which allow you to actually see the divided money. It’s easier to fit into your wallet. You could use different colors and designs to help separate the categories. But like the envelopes, when the money is gone, it’s gone.
Mvelopes: The budgeting app Mvelopes utilizes many of the envelope system principles. It allows you to set aside money in advance and spend from how much is remaining in a selected category. When the money is running out, you are faced with choices — no purchase, buying something less expensive or moving money from another category.
Goodbudget: The Web site and mobile app Goodbudget allows consumers to allocate their money into different categories and track their spending. For an additional fee, consumers can get a more intricate system.
Most of the sites/apps, as a matter of course, will recommend the 50/30/20 system of budgeting. That means putting 50% of your after-tax income toward your needs (such as rent and groceries), about 30% toward wants (such as traveling and eating out) and about 20% toward savings and debt repayment.