If you’re new to budgeting, you don’t need a complicated system to track your finances. One of the most powerful steps you can take is to understand where your money goes each month and where you can cut back.
Creating an envelope budget is a simple method that can help. By allocating cash into different categories – or envelopes – each month, this method creates more awareness and discipline about your spending. It’s a visual tool that inspires you to be more conscious about your finances.
“I’ve always believed that envelope budgeting works because it makes intangible spending tangible,” says Eric Kroc, CFP and Accredited Wealth Management Advisor at Kroc Capital. “Putting notes and coins in a jar hurts. That pain doesn’t exist when you press a card.”
By adding this friction to your purchases, you can better understand where you’re spending unnecessary cash and create extra room in your budget.
Here’s what you need to know about this tried-and-true budgeting method, and whether it’s right for you.
What is envelope budgeting?
Envelope budgeting is a technique used to limit spending by allocating cash to specific spending categories, such as eating out, shopping or groceries.
When the envelope runs out of cash, you stop spending in that category. You fill out the envelope regularly, such as every month or after receiving your bi-weekly pay.
Traditionally, this is used with physical cash and envelopes, but there are also digital devices that support this method.
What is the purpose of envelope budgeting?
The main goal of the envelope budgeting method is to create visibility and boundaries around your spending. “The envelope method is less about cash and more about behavior,” says Christina Wiebelt-Smith, CPA and senior wealth advisor at Gertsema Wealth Advisors.
The physical envelope with the cash makes it easy to see when the funds are running low. Also, physically handing over cash on purchases may make you think twice before making a sudden purchase.
This awareness can lead to more thoughtful spending habits over time. “The big lesson is that envelope budgeting is not meant to be your permanent solution. It’s training wheels for your brain,” says Wiebelt-Smith.
How does envelope budgeting work?
Once you understand this, envelope budgeting is easy. Here’s how to get started:
- Create expense buckets: Decide which categories you want to track with envelope budgeting. Wiebelt-Smith recommends starting with discretionary categories, such as dining out, clothing, and entertainment, as these are common “problem” areas for overspending.
- Set realistic spending limits: Choose a spending limit for each category that fits your budget and is realistic for you. The goal of the limit is to create a firm spending limit, not be overly restrictive.
- Fund each envelope: Label each envelope and withdraw cash to fill each category. If you’re using this method digitally, you can allocate money across multiple bank accounts or a “bucket” account or allocate money to categories within the budgeting app.
- Spend only what’s in the envelope: This is the key to envelope budgeting success. Kroc strongly recommends carrying money between classes or supplementing with a credit card. “If your envelope gets empty, you should stop spending. Otherwise it’s not working,” he says.
What happens if I go over budget in a category?
Ideally, once you’ve met your budget in a category, you should stop spending until it’s time to refill your envelope. Giving yourself too many concessions can ultimately undermine the purpose of the envelope budgeting method. Delaying or skipping unnecessary purchases can create more discipline and awareness of your spending habits. If you repeatedly struggle with spending more than your allotted amount, you may need to re-examine your habits to reduce the temptation to spend in problem categories.
That said, if you’re consistently going over budget in any category, you may need to reconsider your limits. Your limit should challenge you to be sustainable while also spending thoughtfully and within your means. It may take some tweaking to find the range that works best for you.
Cash vs. Digital Envelope Budgeting
Traditional envelope budgeting relies on physical cash and envelopes, which is not always compatible with online shopping and card-only transactions.
“This method is more challenging today than it was 20 years ago,” Wiebelt-Smith says. “We order groceries for pickup, buy gifts online and shop through apps and websites.”
However, solutions do exist. “Many budgeting apps and online bank accounts allow you to allocate dollars to specific categories and track balances, much like physical envelopes, but they can better accommodate online spending,” says Wiebelt-Smith.
You can also use a hybrid system. For example, you can allocate cash to categories you typically spend more on, like eating out and shopping, while keeping other expenses digital.
Who should use envelope budgeting?
Creating an envelope budget is a simple method that can help you reduce your spending. But it doesn’t fit every lifestyle.
Who is envelope budgeting best for?
Wiebelt-Smith and Kroc recommend creating an envelope budget for people who:
- New to budgeting and want to understand your spending habits
- Consistently overspending in discretionary categories
- Spend money on small purchases that quickly add up
- are visual or practical learners
- Use cash regularly and spend money personally
- Spending more when using debit or credit cards
Who is envelope budgeting not ideal for?
Envelope budgeting doesn’t work for everyone. Wiebelt-Smith and Kroc point out that this method is not ideal for people who:
- make frequent online purchases
- Rely on credit cards too much
- There are many bills on autopay
- Concerned about carrying large amounts of cash
- Live in homes where multiple people spend time, as this makes coordination difficult
Envelope Budgeting vs. Other Budgeting Methods
Depending on your goals, envelope budgeting can be used with other budgeting methods. Compare Different Budgeting Techniques:
- Envelope budgeting: allocating cash in envelopes for different expense categories; Best for: Limiting overspending
- The 50/30/20 rule: dedicating 50% of income to needs, 30% to wants and 20% to savings; Best for: Simple but comprehensive budgeting
- Zero-based budgeting: Assigning every dollar a “task,” so that your income minus expenses equals zero; Best for: detailed tracking
- Pay Yourself First Budgeting: Automatically transferring a pre-determined percentage of your paycheck to savings or investments; Best for: Automating savings
Bottom Line: Envelope Budgeting
Envelope budgeting is one of many ways to take control of your finances through understanding where your money goes and building discipline.
If you’re a beginner budgeter, this can be a simple and effective way to keep track of your spending habits. It helps create boundaries around your finances by giving you a visual indication of how much you have and when to stop.
However, with so much spending being done online or with credit cards these days, traditional envelope budgeting doesn’t always fit many people’s lifestyle. Digital options like Monarch Money can make this easier.
Frequently Asked Questions
Does envelope budgeting really work?
Envelope budgeting works for many people because it creates clear, concrete spending limits. This helps you see where your money is going.
Can you use the envelope budgeting method without cash?
Yes, you can use the envelope budgeting method digitally through budgeting apps, multiple bank accounts, or bank account “buckets.” The key thing is to separate your spending categories and allocate an amount to each.
What happens when an envelope is empty?
When an envelope is empty, you should aim to stop spending in that category until it’s time to refill it. “The main rule here is that there’s no miserly $20 loan made between categories halfway through the month,” says Kroc.
Is envelope budgeting the same as zero-based budgeting?
Zero-based budgeting is a method in which you allocate every dollar of your income each month to a specific role. Creating an envelope budget is similar to how you allocate money to different expense categories. However, envelope budgeting focuses on keeping physical cash in a few “problematic” categories so you can spend wisely and stop when you run out of money.
Can envelope budgeting help you save money?
Envelope budgeting can help you save money by placing limits on your spending and reducing impulse purchases. It also helps you be more aware of where you’re spending money by giving you a visual cue when to stop.
This article originally appeared on USA TODAY: Envelope budgeting: What it is and why it’s so popular