Budgeting Basics - Step 9 - Envelopes

When you budget based on your annual income and expenses, using an "envelope system" can work to your advantage.

You have probably heard about people putting money into envelopes to put that money aside for different types of expenses. You might have an envelope for clothing or one for groceries, for instance. When a paycheck comes in, certain amounts are allotted to go in each of the envelopes. Then those expenses are paid from that amount.

Using a system like this lets you consider your whole year when you budget while still managing your money month by month or paycheck by paycheck. Putting certain amounts of cash into designated envelopes throughout the year allows you to plan for future needs while still meeting your immediate obligations.

If you budgeted for annual expenses that are flexible or unscheduled or infrequent (haircuts that are less often than monthly, clothing, gifts, car maintenance, vehicle registration, and other similar types of expenses), you know in advance that some time during the course of the year you will need a certain amount of money (maybe an exact amount or maybe an estimated amount) for each of those expenses. You can take that list of expenses that are less frequent than monthly and divide each one by 12 to get a monthly amount (or by 52 for weekly or by a number that represents the number of paychecks you have each month). That tells you how much money needs to be put aside each month (or each week or each paycheck) to help prepare for that expense. Each month (or each week or each paycheck) that much cash is put into an envelope marked with that category. Then when that expense comes due or that money is needed, the cash is already set aside and available to be used, without affecting the other regular expenditures.

Clothing, gifts, and school supplies inevitably must be bought. Looking at your annual budget lets you know how much you can reasonably spend on each of these categories while still meeting your other financial goals (including saving for emergencies, retirement, and other needs). Putting aside a small amount each month (or each week or each pay period) lets you spread the cost throughout the year, and then when you have an opportunity to buy at a discount or you have a pressing need, the funds are available to take advantage of that discount or meet that need.

The envelope system can be helpful for more frequent expenses too. For instance, if you take out cash to pay for groceries, you can easily see how much money is available for groceries even if you shop more than once per pay period or have multiple people shopping or shop at more than one store. You can save some of that grocery money until there is a sale or other opportunity to buy a large amount of some staple at a low price.

Using cash in envelopes eliminates the need to track what each person is spending on what--when the cash leaves the envelope, no more can be spent until the next set of cash comes in. This helps prevent overspending, so that you can actually stick to your savings goals.

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If you see that an envelope has "enough" cash in it already, you can stop adding money to that envelope and use the designated amount to fill some other envelope or to apply to paying down debt or to reaching a savings goal. You can even put an amount on the envelope to remind yourself how much you are needing in it. Once that amount has been reached, instead of adding to that envelope each month (or each week or each paycheck) you would allocate that amount to a different goal until the funds in that envelope drop below the target amount.

If you are only able to put very small amounts of money toward some goal each month (or each week or each paycheck), that's ok. Once you have saved enough to be able to purchase what you were saving for, then you are able to make that purchase with a clear conscience, knowing that you aren't jeopardizing any other financial commitments.

If you are very disciplined and organized, you can do this without putting cash in envelopes. But before you try "virtual" envelopes, you might try the physical ones first to be sure you can do it, and if you start slipping up when you try the virtual kind you should return to the physical model before you get your finances out of whack.

Physical envelopes don't have to be envelopes.  They can be jars or coffee cans or folders or whatever will securely keep your money organized.  We use pencil pouches that are meant to go in a three-ring binder.  My brilliant husband took the cardboard that was inside the pouch showing through the window on the front, turned it over, and wrote the label on the back.  Now the label shows through the window on the front of the pouch.

Not all the money you are saving should be kept as cash.  Money you'll be saving for a long time (such as saving for a vehicle or vacation or a new large appliance) can be kept in a savings account, either a separate account or in an account with other funds where you keep track yourself of how much of the money applies to what goal.  Also, if some categories start accumulating really large amounts, you'll have to decide if you should put that money in savings, stop adding to that category until the amount in it drops below a certain threshhold, or go ahead and use the money.

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