How To Budget Using the Envelope Budgeting System

The envelope budgeting system shows you exactly how much money you have left to spend in each budget category and prevents overspending by using cash and envelopes.

Setting up a budgeting envelopes system with cash and a white envelope.
Budgeting using the envelope system.

What Is Envelope Budgeting?

Envelope budgeting is a low-tech budgeting method that allocates cash to each of your spending categories. That cash is stored in separate physical envelopes labeled with the category.

For example, if you budget $500 for groceries for the month, you would put $500 cash in an envelope marked “groceries.” You use cash from that envelope to pay for your items when you go grocery shopping.


Key takeaways:

  1. With the envelope method of budgeting, you place the appropriate amount of cash for each spending category in a labeled envelope.
  2. Using envelopes for budgeting allows you to track all your expenses at a glance, but it requires large amounts of effort and cash.
  3. You can employ envelope-style budgeting using a spreadsheet or budgeting app if you’re uncomfortable keeping envelopes filled with large amounts of cash.

How Does the Envelope System Help With Budgeting?

Using envelopes for budgeting can be especially helpful if you’re new to living on a budget or trying to eliminate bad spending habits. The envelope method of budgeting is a cash-based system that forces you to stick to your budget. Once the cash in an envelope is gone, you can’t spend any more in that category until the next budget cycle.

Multiple studies have shown that people spend more shopping with a credit card than with cash. This MIT study found that people spend up to 100% more when a credit card compared to cash. Using the envelope system and paying for purchases in cash may help you get your spending under control.

Budgeting With the Envelope System

Cash and a red calculator on a desk.

Budgeting using the envelope system is simple, but there are a few steps you need to take to set it up. Here’s how to start budgeting using the envelope system:

Step 1: Add Up Your Monthly After-Tax Income From All Sources

You first need to know how much money you have coming in for the month. Your sources of income could consist of the following:

  • Paychecks from your job
  • Paychecks from a second job
  • Income from a side hustle
  • Investment earnings
  • Child support or alimony
  • Social security or government benefits
  • One-time payments, such as a tax refund or annual bonus

If you’re self-employed or work on commission, you might have an irregular income. Use your average monthly income for the last 12 months.

Step 2: Review Your Expenses and Set Spending Categories

The second step with envelope system budgeting is creating budget categories. You’ll need your credit card and bank statements to budget for variable expenses and discretionary spending.

You can create a category for anything you spend money on. You might have your fixed expenses, like rent or auto insurance premiums, on autopay through your checking account. If so, you can use budgeting envelopes for discretionary expenses and expenses that fluctuate month to month. Common categories include:

  • Groceries
  • Gas
  • Eating Out
  • Clothes
  • Pet Care
  • Entertainment
  • Personal Care

You can go broad or get granular with your expense categories. For example, you can have a hobbies envelope, or you can split that out into separate envelopes, like a golf envelope and a quilting envelope. It might take a while to determine which envelope categories work best, but you can always adjust.

Once you’ve decided on your categories, grab an envelope for each category and write the category name on the back.

Step 3: Assign a Dollar Amount for Each Category

Once you’re clear on how much money you make and where it goes, determine how much to allocate to each category. Having reviewed your monthly expenses, you should have a solid grasp of how much each category requires. If you noticed a category you tend to overspend in, you might assign a lower amount to that category to reduce your monthly spending.

Step 4: Fill Your Envelopes With Cash

If you get paid twice a month and budget $500 for groceries for the month, you’ll put $250 in your groceries envelope per paycheck. On payday, withdraw the funds for your envelopes from your bank or an ATM. Divide up your cash and put the proper amount in each envelope.

Step 5: Spend Using Money From the Appropriate Envelope

The keys to making the envelope budgeting method work are:

  1. Only using money from the corresponding envelope
  2. Not spending more than you have in each envelope

For example, if you’re buying a new sweater, you can only use money from your clothing envelope. Once the money from your envelope is spent, you’re done buying clothes.

If you have impulse buying issues, leave your debit card and credit cards home. That will leave you little to no room for straying.

Can I borrow from other envelopes?

You can borrow from other envelopes, but it defeats the purpose of using cash and envelopes to manage your money. The envelope system is designed to help you control your spending and stick to your budget. If you run out of money early, you might need to adjust your budget next pay period.

If your envelopes are consistently running out too soon, you may have underestimated the amount needed for one or more categories. If you’re taking from other envelopes for impulse purchases, you’ll have to learn to go without and stick with the plan.

Using physical envelopes and actual cash requires planning and self-discipline. You may need a few budgeting cycles before your numbers are dialed in. Getting used to paying for everything in cash and having a hard stop also takes time.

What if I have cash left over at the end of the month?

If you manage to come in under budget, you can do a few things with the money. You might:

  • Reward yourself with a little treat
  • Put the extra money toward debt repayment
  • Add it to your emergency fund
  • Deposit it into a savings or investment account
  • Roll it over into next month’s budget

Do what you want with the extra cash within reason. You can consider it fun money or put it toward savings goals, retiring credit card debt, or other financial goals.

Pros and Cons of Envelope Budgeting

Using the cash envelope system to budget your money can improve overall financial health, but it’s not without downsides. Consider the following advantages and disadvantages and then decide if it’s right for you:

ProsCons
Helps you track spendingMust store and carry large amounts of cash
Enforces spending limitsCan be time-consuming and cumbersome
Makes you more mindful and may make you spend lessNo cash back, travel rewards, or online purchases
Curbs impulse purchasesPotential for loss or theft
Prevents overdraft fees and helps you stay out of debtSharing bill paying or shopping duties with a partner is harder

Envelope Budgeting Alternatives

Female professional at her desk using a budgeting app instead of cash envelopes.

Using actual cash and physical envelopes to control your spending can be impractical and labor-intensive. If you like the idea of the envelope system but don’t want to store and carry cash in paper envelopes, you can apply the same principles with a digital approach. Consider the following budgeting apps:

  • Goodbudget – Based on the envelope budgeting system, Goodbudget uses virtual envelopes to track and plan your finances.
  • EveryDollar – Simple budgeting software from Dave Ramsey. EveryDollar allows you to create a zero-based budget.
  • Qube Money – Part bank account, part budgeting app, Qube Money uses digital envelopes and a linked debit card to replicate the envelope budgeting process.
  • You Need a Budget (YNAB)YNAB also uses a zero-based budgeting strategy. Gets you planning ahead rather than simply tracking past spending.

Using digital tools can be a good way to get the benefits of the envelope method without the hassles. However, using cards instead of cash may make it harder to stick to your spending plan.

Does Envelope Budgeting Work?

Envelope budgeting can work for you if you are self-disciplined and don’t mind carrying and paying for things in cash. Envelope method budgeting can help impulsive spenders or those new to budgeting develop good money habits, reduce spending, and avoid debt.

If you already use a budgeting system, like the 50-30-20 rule, you can combine it with envelope budgeting. Adding the element of paying in cash to your existing budgeting technique can give you the best of both.

You can also use an app to create virtual envelopes. Apps make keeping precise records easier and eliminate the need to carry cash, but enforcing category spending limits is more difficult.

Image Credits: Pexels

Sara

Sara Graham

Sara Graham is a frugal living and household budgeting expert. Her writing has appeared on MSN Money, The Good Men Project, Fairygodboss, and several other online publications. She is the co-founder of KindaFrugal.com, a personal finance and frugal living blog.