An Update to the Envelope Budgeting System

The envelope budgeting system has been around for a long time. Our grandmother’s grandmother used it to control the household finances. It’s a time honoured system because it works. However, modern banking and finance means that the old cash in the envelopes system is in need of an overhaul.

I’ve outlined the modern day envelope budgeting system that I use below. First, however, traditional envelopes system:

1. Every payday, budget out your pay. Work out how much you will need for the groceries, how much for the petrol, how much for the bills etc.
2. Divide your cash and fill your envelopes. Withdraw the amount of cash you need and put it into separate envelopes. Each envelope holds the amount allocated for each of your spending categories. It’s not necessary to have an envelope for everything you spend your money on just the main categories. For example, you may have an allowance envelope for things like coffee, newspapers and other personal discretionary spending, a groceries envelopes, a petrol envelope etc.
3. Spend until it’s gone and spend no more. If you spend all the money you have allocated in the first few days, it means you have to make do until your next payday.
4. Put any leftovers into savings. If you have any money left over in any of your envelopes, put this aside into your savings account.

An important aspect to this system is that you are spending cash. The reality of handing over cold hard cash hurts, so you are more conscious of your spending and less likely to overspend.

There are however, a few drawbacks to this system. For example, you see a really good bargain on bulk rice, but can’t take advantage of it because you’ve spent all your grocery money for the month. Of course, one way around this is to have an envelope for surprise bulk purchases.

I used this system a few years ago, but my envelope was a book I knew no one would ever read. My cash was divided up by chapter. Chapter one was for the groceries, chapter two was for the rent, chapter three was for the electricity…

I would use the envelopes / book system specifically to plan for the upcoming bills. For example, the electricity bill was quarterly and cost around $200. I got paid fortnightly, so I needed to put aside $35 each payday to be able to cover the electricity bill. When the bill came, I had the cash ready and waiting to pay it. I would do this for all bills including annual bills such as the car rego.

This system worked well at the time (particularly because I paid everything with cash), but it was well overdue for a modern update.

The down side to the conventional envelopes system was twofold:

1. I pay my bills electronically
2. Having large amounts of cash hanging round the house is not only asking for trouble, I’m not earning any interest on it.

Envelopes Updates

This system is similar in principle, but with a modern twist.

1. You will still need to budget your money and spend within your allocated budget. As with the electricity example above, use your budget to calculate how much you need to put aside each pay day for upcoming expenses.
2. Pay yourself first. Allocate money for investments/ savings first, then any debts, then fixed expenses such as insurance or utilities, then spend what’s left.
3. Draw only the cash you need for the week’s allowance money and any other cash expenses like petrol and groceries. Once this is spent, that’s it for the week.
4. Alternatively, use your budget to monitor your spending and whether you are spending within budget. When you reach your budgeted amount, no more spending.
5. The amounts that you allocate for expenses goes into a high interest bank account rather than drawing cash and stashing it into envelopes.
6. Keep track of how much you have saved and allocated for each category, by keeping a record of your savings account balance, broken up into your expense categories. This can be done on paper or in excel. When I first started this, I kept an exercise book with a page per expense, and a total page that equalled what I had in the bank. Now I use a spreadsheet in combination with my budget. I still allocate an amount each fortnight to the electricity account, for example, but it goes into a bank account instead of into an envelope.

(Update: since writing this, there are now banks that allow you to have several savings accounts without fees, so that you can divide each expense into a separate savings account.)

Keeping your money in a bank account means you are earning interest and it is still allocated into virtual envelopes.

Taking it one step further

I know credit card debt is talked about as the most evil thing from hell at the moment, but using your credit card wisely can pay off.

• When the bills come, you know that you are able to pay them in full because you have saved your cash and allocated it towards the bills.
• Rather than using your savings, use your credit card to pay the bills.
• Pay off your credit card in full every month with the allocated cash in your high interest savings account to ensure that you accrue no interest on you card.

This method works well if you have no outstanding debt already and pay your credit card balance off in full every month. Using your credit card to pay the bills means that you are earning interest for longer on your savings and you can take advantage of any loyalty programmes offered by your credit card merchant. Using a credit card and paying it off on time will also establish or improve your credit history.

Have you read these posts?

1. budgeting for irregular income
2. pre-paying bills
3. budgeting basics – creating a simple budget
4. managing electronic bills
5. how to make saving money as easy as doing nothing