L Bee Note: While I am working today, enjoy this guest post from the folks over at Your Finances Simplified, another bang-on PF site. I've never used the envelope budgeting method (mostly because I was scared of running out!) but I appreciate the step-by-step how to below. Check it out!
Long before the iPhone, finance apps, the Ipad and even before (gasp!) the Internet, our grandparents came up with some pretty powerful ways to set money aside. More and more people are starting to realize that their savings strategy just isn't working. Worse still, some are just waking up to the fact that they might not even have a strategy at all.
How to Do the Envelope Budgeting Method
Not So Ancient Wisdom
What is the ancient but effective savings strategy? Would you believe something as archaic as an envelope? That’s right, a real, hold it in your hand, paper envelope. Some modern financial pundits have uncovered this proven savings system and have renamed it as the “envelope savings system.” Most likely grandma didn’t use such a fancy sounding name, but it doesn’t matter what we call it, the system really does work.
How Does It Work?
The heart of this system involves putting cash into envelopes you label for specific bills. It is certainly true that using cash may sound quaint and more trouble than it’s worth. However, keep reading and you will soon understand the hidden power of this system.
You see, the experience of using physical cash triggers a different psychological reaction inside of you that you may not even be consciously aware of. Unlike whipping out your credit card when you are dining out at Fridays and blissfully signing the credit card slip using cash triggers a different part of your brain. Incredibly, opening your wallet and pulling out cold hard cash triggers a pain response in your head. Can you see how using cash is a natural deterrent to overspending? That explains the cash part.
What is this about envelopes?
Envelopes are a tool for you to set aside money for certain expenses that you pay every month. The point of using a real envelope is that the envelope serves as the complete budget for that expense each month. For example, suppose you set up an envelope labeled dining out. Knowing that you and your significant other like to dine out on Friday nights, you decide to budget $75 per week for dining out. That means you put in $75 times 4 or $300 into the envelope labeled dining out. Now here is the key point: when the money in the dining out envelope is gone, so is your dining out for that month. Are you following along here?
No Pain Budget
This envelope savings system really serves as a NO PAIN budgeting system. Note this is definitely not at all like the coaching from the personal trainers who constantly remind you that “no pain no gain.”
Nope, none of that kind of stuff here. The envelope system really is a painless way to set aside money for the expenses you know you will have as well as the things you want. In other words, no pain equals your gain.
The Actual System
Setting up your personal envelope system only requires only a little bit of effort on your part. First, take a look at your monthly expenses. For most people, the best strategy is to separate your expenses into two broad categories.
Call these two categories: Fixed Expenses and Variable Expenses. Your fixed expenses are exactly what they sound like, and they include bills such as your monthly rent or mortgage payment, your car insurance, car payments, and other expenses like those. Your variable expenses are those expenses that seem to go up and down every month. These would be categories such as groceries, dining out, clothing, etc.
Working the System
Now you have divided your expenses into fixed or variable categories. Next it’s time to work the system. The fixed expenses are best to pay with auto-pay. For example, your insurance payment comes straight out of your checking account each month. Total up all of your fixed expenses and make sure you keep that amount in your bank account.
The remainder of the money comes home with you. At this point, you want to carefully divvy up your cash into all of your envelopes. There are two things to keep in mind when you are stuffing your envelopes. Make sure you have an entertainment envelope. Also, in the beginning you are probably better off if you include an envelope you label Safety Net. The Safety Net envelope is only there should you find that your underestimated one of your variable expenses.
Key to the System
The key to the envelope system is that you never ever “rob” one envelope to pay an expense from another. The only exception to this rule is using money put into the Safety Net as you set up and fine tune the system in the first few months. The problem areas are most likely to show up in the dining out or the entertainment envelopes. If you get to the middle of the month and your dining out envelope is empty, that should tell you something. Either you set aside an inadequate amount, or you are spending more than you think you are.
This envelope savings (no pain budget) system really works…if you play along and follow the rules as outlined above. This system allows you to take control of your spending, and you may well find yourself with more money left over at the end of the year.
Jim Gibson is a freelance writer who writes for Your Finances Simplified. He is passionate about finance, especially personal issues, and martial arts. He spends his time writing on financial topics when he is not training or spending time with his beloved wife.