The Envelope System: a Simple and Effective Budget
The purpose of budgeting is to make us aware of our spending habits. An overly complex budget can be counter productive and time consuming. One simple type of budget is "the envelope system." Place cash to cover discretionary expenses into categorized envelopes monthly and spend money from the envelopes until it is gone. Simplify your budgeting and make it more usable through the envelope system.
As a newlywed couple, my husband and I made the same mistake many young couples do when they first get married - we had no budget plan. At first, it didn't seem necessary because our income was modest, and our living expenses were very simple. I was finishing my last year of college and worked a part-time job and my husband was finishing his doctorate and had found a nice full time job in his field. We lived at the bottom of a hill right next to the University in a one bedroom apartment that cost $350 a month, utilities included. We didn't even have a car payment. So we didn't even think about a budget, but just doing our best and getting through school.
Soon enough, about three months into our marriage we started to notice something. Where was all our money going? It was all going out the door every month, but it was a large enough chunk was that it made us take notice of the way we were spending on simple things like groceries, eating out, household expenses, and gifts.
Then, we were told about a very easy personal finance system called "The Envelope System." It is so simple and flexible that is can be used by and tailored to any person or lifestyle.
First, you start out by buying some plain envelopes - any kind will do.
Second, on a separate piece of paper, list all your main discretionary expenses such as: dining, entertainment, groceries, household, gifts, vacation fund, etc. Basically, any expenses in your life that you have control over, not loans, or insurances, utilities, and such. When we first started The Envelope System six years ago these were our discretionary categories that we came up with: Groceries, Dining, Entertainment, Household Expenses, Gifts, Vacation fund, and Gas.
Third, label each envelope with one category and decide how much money should be put in each category each month, bi-weekly, or week - however you decide is best for you. We decided to put our funds in each category on a monthly basis. At the beginning of the month, when our paychecks came, we took out a certain amount in cash and divided it up into our envelopes. How much you put in each envelope is entirely dependent upon your own lifestyle and income. Some choose to put $100 in their monthly dining out envelope per a month while another may need $400. The key is setting a budget that is within your means, but gives you a little room at the same time; and if you don't use all the money from one envelope category that month it can roll over and add to the next month's envelope. It took us a few months to find the right categories and the rights amounts for each envelope. For example, shortly after starting, we realized that Gas was not really a discretionary expense for us. We also realized that I needed some money to spend each month on things I need without having to make justification and without feeling guilty.
Fourth, and last, adjust your envelope system as needed. After a couple of months you may discover you need a little bit more or less in a certain envelope category than you first realized. You may also discover a new category that you need. Review your system every so often as inflation takes place, the economy changes, and your living situation changes. Make sure it isn't overly tight or way too loose.
We've adjusted our system over the years a few times. As jobs change, children show up, or as inflation at the grocery store never seems to end. Now after six years these are our categories: Groceries, Dining, Entertainment, Household expenses, Gifts, Vacation fund. We also have a separate envelope each for my husband and I to use at our discretion without guilt or scrutiny.
The principles of the envelope system are that discretionary money is controlled as cash. The benefits are that when paying with cash, we are more aware of how our money is being spent, plus, there is a physical limitation to overspending, when the envelope is empty, then we have reached our budget. Some months it is easier than others to have cash left over; and when money rarely makes it to the end of the month, it usually means it is time to make adjustments either to the budget or ones habits.
Our situation has changed a number of times through the years. We now have significantly more income than expenses but still use the envelope system not necessarily to restrict our spending but to keep us aware of our spending. As our situation has changed, our situation will continue to change and we will adjust our envelopes as necessary. This system has simplified our finances and kept our spending where we think it should be (according to our needs and lifestyle) for six years now. If you're looking for a new way to budget, consider the envelope system; it could save your considerable money and stress.
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ABOUT THE AUTHOR
Kari Hoopes is an investor, entrepreneur, and writer. She is the owner of the popular Sweetly You Bath and Body company. Learn more about Money Management at Hoopes Financial