The cash envelope system keeps you honest in your spending. With cash in envelopes for each category of your spending, you have a strict budget you must follow. If you go over, you are out of cash – that’s it. If you are under, you have reason to celebrate.
Keep reading to learn how to budget and save money with the cash envelope system.
What is a Budget?
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A budget is a spending plan based on the income you make. It’s a birds’ eye view of where your money goes every month, whether you spend it on bills or in other areas. Knowing how much you spend is important as it helps you set up financial goals and ways to achieve them for your future self. A budget helps you learn how to save money from your salary, commission, or fixed income.
What is Cash Envelope Budget System?
The cash envelope budget method helps you learn how to budget and save money by using cash. Unlike when you pay for items with a credit or debit card, cash can’t be replaced. Once you spend the money in your envelope, you can’t spend anymore.
With the cash envelope system, you have envelopes for each category of spending. You place the appropriate amount of cash in each envelope that you have budgeted for the month. As you pay from each envelope, the cash decreases. Once the cash is gone, you are done spending in that category. At the end of the month, you tally up what you have left to see how you did.
How to Start Cash Envelop System
So how do you make the cash envelope budget system work? Use these simple steps:
1.Create a Budget
This is the hardest step. You have to get real with yourself. Take your bank statements over the last few months or even year and look at your expenses. Where do you spend your money? Where can you cut corners? Remember, you’ll be paying cash for everything, so there is no more overspending and throwing it on a credit card.
Next, you need to figure out your financial goals. Do you want to:
- Get out of credit card debt
- Buy a house
- Save for a vacation
- Maximize your retirement contribution
- Save for your children’s college education
These are just some ideas – you can add your own long-term financial goals. It’s important to write them down because you are more likely to make them a reality when you see what’s really important to you.
2.Cash Envelop System Categories
Once you have your budget, you must create categories or wallets. Below we’ll show you the most common categories, but you can add or change them as needed.
- Car maintenance
Types of Monthly Expenses for Cash Envelope Budget Method
Fixed Expenses for Cash Envelop Budget System
Keep in mind that there are fixed and variable expenses you’ll have each month. As you create your budget, you must factor in the fixed expenses first, working the variable expenses in as you can.
- Housing payments
- Car payments
- Student loans
- Personal loans
- Life insurance premiums
- Health insurance premiums
- Cell phone bills
Variable Expenses for Cash Envelop Budget System
Variable expenses are those that may change from month-to-month. A few examples include:
- Household expenses
You must include utilities, food, and gas in your budget; even though they are variable expenses, but clothing, household expenses, and gifts have a little more wiggle room. In other words, if you don’t have the cash for those expenses one month, you may have to skip it. You have to learn ways to save money on a tight budget.
Determine Monthly Budget Limit for Each Account
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It’s important that you determine the limits for each account every month. If you have variable income, your amounts may change from month to month. If you work on a salary or have a fixed income, it’s easier to budget every month, knowing your fixed and variable expenses for the year.
Knowing how much to spend in each category can get tricky. As a general rule try spending around 25% of your income on housing, 10% on utilities, and 10 – 25% on insurance, and 10 – 15% on food. Each person’s budget will differ, but these guidelines can help you see where you stand.
Once you create your budget, create an envelope for each category. On each envelope, write the amount of cash that the envelope should contain.
3.Withdraw Funds From Main Account
Immediately after the budget set, withdraw the exact amount of cash needed for each category and place the funds in your envelope. Make sure you label the outside of each envelope with the category name and the exact dollar amount you are placing in the envelope.
4.Spend Cash From Envelops Appropriately
Now is when the real test starts. Once you place the money in the envelopes, it’s go time. When a bill is due, you pay it from the envelope. This works great for purchases you make in person, such as gas and groceries. Where it gets tricky is online purchases. You have two options:
• Leave the appropriate amount of funds in your bank account, knowing that it’s for the specified bill
• Take the cash out and deposit the cashback into your account right before you pay the bill, this way you know you won’t accidentally spend the money meant for your housing payment or phone bill
5.Track Your Spending
Tracking your spending is the only way to make the cash envelope system work. It teaches you how to budget and save money. You can track your spending in one of two ways:
• Pencil and paper – Many people still prefer to keep track of their expenses with a standard log. If that’s you, go for it. Just make sure you log every single expense. You can do it formally on a spreadsheet or write it on the corresponding envelope, whatever is easier for you.
• Electronically – You have many options for electronically tracking your spending. There are numerous free apps, such as Mint or You Need a Budget, as well as PC programs, such as Buddi or Budget Pulse. You can even set up your own Excel spreadsheet. You can choose to have your bank statements directly synced with your accounts or you can update the logs manually.
It doesn’t matter how you track your spending, it just matters that you do it. Sure, you could just wait and see if you have cash left in each envelope at the end of the month, but that doesn’t tell you where you over or underspent. You need hard data to help you budget correctly for the months moving forward.
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Emergencies happen to the best of us. You can’t predict them and if you don’t have the funds in an emergency fund, it can cause pure panic.
First, gather yourself and figure out what you need. How much money will the emergency cost? Next, evaluate the status of your ‘other’ envelopes. Which envelopes have room for you to borrow from them without affecting the timeliness of paying your bills? It’s best if you talk this step over with your partner or someone you can trust if you are single. Making the decisions on your own while in a state of panic may result in poor decision making.
What if You Run out of Cash from a Category?
Despite your best efforts, you may find that you run out of cash in a category or two. Use it as a learning lesson, but DON’T borrow from another envelope. Most commonly, this happens in entertainment, dining out, food shopping, or clothing shopping envelopes.
It can be tempting to reach over and grab the excess amount in another envelope, but that defeats the purpose of the cash envelope system. Instead, chalk it up and learn to stay steadfast in your decisions to avoid overspending.
Related reference: How to create a budget
Leftover Cash From Envelop Budget Category?
If you have cash leftover in an envelope, congratulate yourself! You’ve figured out how to budget and save money! You can do a few things with the money:
Splurge a little – Going under budget is a reason to celebrate, just keep it minimal. Don’t go blow all of the extra funds, but rewarding yourself can serve as a great motivation.
Roll the money over – You can roll the funds over into next month, padding one of your favorite envelopes a little bit, such as clothing or food.
Pay down debt – If you have debt you want to get rid of, use the extra funds to pay the debt down.
Save the money – If you have other financial goals, such as a down payment on a house or setting up an emergency fund, stock the extra money away in the appropriate account and consider yourself one step closer to meeting your goals.
Pros of Cash Envelope Budget System
You are forced to be disciplined – With a set amount of cash for each category, it’s harder to overspend than it is when you swipe plastic and carry a balance.
Plan before you shop – Heading to the store and grabbing things as you see them is the easiest way to go over budget. With the cash system, you must plan accordingly so that you avoid the embarrassment of having to remove items off your bill due to a lack of funds.
Avoid overdraft and bank fees – Using cash doesn’t involve any fees. If you don’t have the cash, you can make the purchase. You don’t have to worry about expensive overdraft fees, interest charges, or late payment penalties.
You have a better understanding of where your cash goes – Mindless spending occurs when you swipe plastic. You don’t realize you are truly spending money until after the fact when you look at your bank account. Having a cash envelope keeps you accountable and helps you make smarter decisions.
No credit card payments to track – Using credit cards means you must keep track of the bills, pay them on time, and decrease the balance as fast as you can to avoid unnecessary interest charges or other penalties. With cash, there are no credit card bills to track, you pay once and you are done.
Cons of Cash Envelope Budget System
• It’s inconvenient – You always have to go to the bank or ATM to get the cash you need. Being able to just swipe your plastic is much quicker, but also much less mindless.
• Tracking your expenses gets complicated – If you don’t write your spending down right away, it’s easy to forget. If you keep your receipts, you can go back and track your spending, but it can waste time and make you frustrated.
• There aren’t any rewards – Cash-back credit cards and even some debit cards offer rewards for spending in certain categories. Cash doesn’t have any rewards, with the exception of avoiding hefty interest charges or overdraft fees.
• Cash doesn’t always work – If you can’t buy an item in person, you may need to shop online. You’ll need to deposit your cash into your account in order to use your plastic to pay for the purchase.
Related reference: How to Effectively Use the Digital Envelope Budget System
Learning how to budget and save money is a learning curve. The cash envelope system can help you figure it out quickly if everyone is on board. It’s important that your entire family understands the importance of paying cash and only using the money allotted for each category in order to stay on budget. It does take some time, but many people swear by this system as it helps them stay on track with their spending.
I hope to see you come back to my awesome blog and join the Investadisor Tribe. My goal is to help millions of people to be financially better off.
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