April 12, 2024
Written by Jackie Lam
AFC® Financial Coach
AFC® Financial Coach
Jackie Lam, AFC®, is an L.A.-based financial writer and educator whose clients include Fortune 500 companies and FinTech startups. Her work has appeared in Forbes Advisor, Business Insider, Salon.com, and CNET.
Creating a reasonable budget can help you achieve your financial goals. Choosing a budgeting approach that matches your working style can help you stick to it.
You might've tried using budgeting spreadsheets or a popular method like the 50/30/20 rule or the zero-based budget. Or you might be one of the 73% of folks who don't regularly use a budget.1
But what about organizing your finances in a more tangible way?
Enter the "envelope system." If you're a visual person, the cash envelope system might be for you. Here, we'll discuss the basics of envelope budgeting and its advantages and disadvantages.
The envelope system is a budgeting method where you create a system with physical or digital envelopes to separate your cash. Instead of paying for things with a debit or credit card, you use cash for everything.
The envelope budgeting system is designed for discretionary spending – the money left over after your bills and necessities are paid off. You divide your funds according to how much you want to spend in a given month on each category. Once you've gone through what's in the envelope, you can't spend any more in that particular category. At the end of the month, you refill your envelopes.
The envelope categories are based on your personal needs and could include:
Groceries
Eating out
Personal care items
Household items
Clothes
Pet costs
Gifts
Car maintenance
Hobbies
Subscription services
Fun purchases
Gas
Entertainment
Other purchases
For example, you might assign $400 for groceries, $200 for eating out, and $50 for household purchases. If needed, you can make changes along the way.
The envelope system may take some time to set up. That said, it's relatively simple to use once you've got your cash divided up.
Here are the steps involved with setting up an envelope budgeting system.
Add up your monthly income. First, figure out your take-home pay. This is your earnings after taxes, deductions, and benefits are taken out of your gross pay. If you have a side hustle, you'll likely get paid different amounts at various times of the month. If you can, try to estimate your average monthly take-home pay.
Choose budget categories. Next, figure out your spending categories or buckets. What do you usually spend your income on? When starting, it might be helpful to create as many envelopes as possible. That way, you can keep a closer watch on your spending. You can also cluster categories down the line.
Assign budget amounts to each envelope. How much you assign to each envelope depends on roughly how much you anticipate spending in a month. To gauge this, look at past transactions on your banking app and at your credit card and bank statements.
Create a buffer envelope. This can be especially handy in the first few months. Have a "bonus" envelope with a bit of buffer cash. That way, if you spend more than expected in any category, you can draw from this envelope.
Monitor and make tweaks. The envelope budget system isn't a perfect science. The goal is to create a system that works for you and helps you keep track of your spending. Feel free to adjust the spending categories and the amount of cash designated for each category. For instance, instead of replenishing your envelopes at the beginning of the month, you may want to do so every two weeks. If you get paid every two weeks, your envelope system resets can sync up with your paychecks.
Digital envelope version: If you use digital envelopes instead of physical envelopes, the main difference is that you would budget through a money management app or by using multiple accounts at your financial institution. This can potentially be easier and safer than using physical envelopes.
Every budgeting system has its pluses and advantages. To determine whether this approach is the right fit for you, consider the pros and cons.
Gives you insight into your monthly spending. By allocating specific amounts to each spending category, you see exactly how much you spend each month.
Can help you avoid overspending. Only being able to use what's in the envelope can help curb spending. You can't tap into your savings account or put it on your line of credit. Once that money is gone, it's gone.
Encourages you to track your spending. When you get a bird's eye view of where your discretionary money is going, you can make tweaks. Maybe you're spending more on fun and entertainment than you realize. In turn, you can increase or decrease spending categories.
Helps you save for your goals. Using cash for most of your purchases may make it easier not to spend money. This, in turn, might help you save for other financial goals, such as setting up an emergency fund, saving for vacation, or saving for a down payment on a house or car.
Can be time-consuming. Taking cash out of an ATM or when you check out at the grocery store, then counting the bills and divvying the proper amount to each envelope can be time-consuming. Like meal prepping, you have to carve out time on a regular basis.
Might be easy to forget an expense. Because you're working with physical envelopes, you won't be able to set up autopay and link it to a debit card or credit card. In turn, a bill might fall through the cracks. It might be helpful to maintain a Google calendar or bill due dates.
Lacks the convenience of using a debit or credit card. If you're using physical envelopes, you'll need to manually track your expenses. Plus, you'll need to record each transaction for bills you'd typically pay with a credit card – like utility bills.
Not as secure as using a debit or credit card. You might have a harder time keeping track of your cash, and if you misplace some of it, you won't get it back.
You might have seen the term "cash stuffing" on social media. Cash stuffing is a technique where you line up a bunch of envelopes, assign each envelope a spending category, and then stuff each envelope based on your budget.
Cash stuffing is functionally the same as the envelope system. The alternate term was popularized on social media as a more fun way to brand the practice.
If you're looking for a new budget to try, the envelope system can help you see exactly what you're spending and help keep you on track. Along with other money methods and steps – like creating an emergency fund, setting up automatic savings, and investing – the envelope budget system can help you gradually build better financial habits.
Remember: How you manage your money should be an ever-evolving process. Explore different options to see which one sticks. And if you want to take your savings further, try the 100 envelope challenge to save $5,000 in three months.
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