What Is Envelope Budgeting?

Taking the reins of your financial life starts with understanding where the money goes. When you have a good budget in place, you’ll also gain clarity and confidence. A budget is your roadmap for building the life you want.

A budget is also one of the most important tools to keep yourself financially secure and moving toward your long-term goals. Without it, it's easy to lose track of where your dollars go. There are a lot of budgeting options out there, but one that's gotten a lot of attention lately is the envelope system. If you're hoping to curb overspending quickly, this could be a great option for you.

What Is Envelope Budgeting?

Envelope budgeting, also known as cash stuffing, is a budgeting strategy that allocates certain amounts of cash to different envelopes, each representing a spending category. Your monthly spending in each category is limited to the amount in its envelope. For example, if you have $50 in a dining out envelope, then you could only spend $50 on takeout or restaurants. 

Envelope budgeting has also gone digital with some online banks offering envelope-style savings accounts where you can direct portions of your income to virtual envelopes. This could be a smart alternative to the traditional envelope system if you don't like carrying around wads of cash.

How Envelope Budgeting Works

Here's a breakdown of how to set up and use an envelope budgeting system.

1. Create your envelopes

Make a list of spending categories and assign an envelope to each. Some common categories are:

• Groceries

• Transportation

• Clothes

• Personal care

• Emergency fund

• Dining out

• Entertainment

If some expenses, like your mortgage payment, are automatically deducted from your bank account, you may prefer to leave them out of your envelope budgeting so you can focus on the bills you have to pay manually.

You might consider using envelope budgeting just for cash and variable expenses, such as dining out, groceries, entertainment, and transportation. Fixed expenses that are usually paid through your bank account could go in a sub-account labeled “bills.” Monthly expenses that don’t work as well with envelope budgeting include:

• Rent/mortgage

• Utilities

• Phone

• Internet

You could also have a Miscellaneous envelope where you keep any extra cash for other expenses that come up.

2. Determine your take-home pay

Note how much you typically take home each month after taxes and deductions, like your health insurance or retirement contributions. Now add up any automatic payments, like your mortgage payment or cell phone bill. Subtract your auto payments from your take-home pay. That’s the amount you have to allocate to your envelopes.

If your income fluctuates over time, figure out the average. It might help to look back at the last several months of your payment history to calculate this.

3. Allocate money to each envelope

Decide how much of your take-home pay should go toward each envelope. Figuring out how much to set aside for variable expenses takes some thought.

You may need to check your last few months of bank and credit card statements to learn more about your spending in various categories. You could take the average and set that as your dollar amount. If you're trying to cut back in an area like entertainment, set a lower limit.

4. Spend only what's in each envelope

Every month, limit your spending to the amount you have in your envelope for each area. This strategy helps you know exactly where your money is going, and it may help you avoid impulse purchases.

5. Adjust accordingly

After you've tried your envelope budgeting system for a month or two, you might find you need to make some adjustments. Maybe you just unavoidably spend more on groceries than you allocated. That's okay. Increase your grocery budget, and look for another area where you can cut back your costs a little. 

If you have cash leftover from one envelope at the end of the month, you could reallocate it to another envelope, roll it over into the next month's budget for that category, or put it toward a savings or debt-payoff goal.

Keep checking in with yourself every few months until you've found a system that works well for you. And if you get a raise or your income changes for some other reason, you'll also want to update your envelope budgeting strategy.

Pros and Cons of Envelope Budgeting

Like all budgeting systems, the envelope budgeting system has advantages and drawbacks.

Pros of envelope budgeting

Some of the advantages of envelope budgeting are:

• Could help avoid overspending. By setting limits on spending in certain areas, you may be able to avoid costly overdraft fees or credit card debt.

• More visual than some other types of budgets. When you're working with physical cash, you have a quick, tangible reminder of how much you have to spend in each area.

• Can be used to help you save for goals. You could create an envelope for debt repayment, a vacation, or other personal goals.

Cons of envelope budgeting

• Frequent trips to the bank or ATM. If you follow the traditional envelope system, you'll have to visit your bank more often than you probably do right now.

• Juggling a lot of cash. Cash is more easily lost or stolen than money you keep in your bank account.

• Loss of credit rewards or points. You miss out on any rewards or cash back programs you could get when you use some credit cards.

Alternatives to Envelope Budgeting

If you don't think the envelope budgeting system is right for you, you can try some other strategies, including:

• 50/30/20 budget. This budgeting method breaks down your expenses into needs, savings, and wants. You limit yourself to spending 50% of your take-home pay on needs (housing, groceries, utilities), 30% toward saving for long-term goals (debt repayment, retirement, a vacation fund), and 20% toward wants. Sometimes these last two categories are flipped.

• Zero-based budgeting. In zero-based budgeting, you give every dollar you earn a role. It might be paying a certain bill or saving up for a long-term goal. It makes you think deliberately about your priorities and where you want your money to go each month.

• Pay yourself first. This strategy might work better for you if you find it hard to save. When you get paid, your top priority is to use an automatic transfer to put some of the money in a dedicated savings account. You budget the remainder for expenses and variable costs.  

• Values-based budget. Instead of percentages or limits, this budget puts your money toward the things that mean the most to you. If you want to donate to a charity or save for a dream vacation, you might find ways to live less expensively so you can free up money for your favorite organization or more travel. 

You may want to try out a few of these strategies to figure out which one works best for you. Or you could check out a budgeting app that helps you keep track of where your money goes. 

It might take a little while to figure out what works, but once you do, stick with it. A solid budget could help you avoid new debt and even be used to pay off existing debt. If you're struggling with the latter, you may have to turn to more serious methods, like a debt settlement program, to get your expenses under control.