What is this system?
The envelope budgeting method is a simple way to manage your finances, pay bills, and save money. It works by setting aside money to pay bills whilst maintaining a personal budget. This popular system is simple, systematic, and has improved my financial position and boosted my confidence with money - and it can do the same for you.
How Envelope Budgeting Works
Step 1. Confirm each category and it's limit
The first step is to write a list of all your spending categories. I tend to do this in groups like such as:
- Fixed expenses where the amount is fixed and occurs regularly (rent, utilities, council tax, home insurance, Internet/TV, etc)
- Living expenses (groceries, dining out, fuel, home improvement, etc)
- Yearly Expenses (Holidays, Amazon Prime, Car Insurance, Road Tax, etc)
- Giving (Birthdays, Christmas, Charity)
- Savings & Investments
The above works nicely as this prioritises the "must afford" expenses over the "desirable" expenses. You can always cut down on dining out, and home improvements, but you HAVE to budget your rent before those niceties.
Once you have a basic format (don't worry - this is an ever-evolving thing so just get the main things nailed first), you can then set spending limits for what you can afford for each category - not what you would like to afford!
Step 2. Grab some envelopes & stuff with "cash"
When I say "cash", this doesn't necessarily mean actual cash. As the world moves towards a more cashless world, it doesn't stop us from being able to utilise envelope budgeting. You can quite easily keep a log of how much "cash" you've put in each envelope on the front - for example:
BUDGET: £100
FUNDED: £100
SPENT: £0and as you spend out of that envelope:
BUDGET: £100
FUNDED: £100
SPENT: £25.50As you can see from the above, you need to carefully track your envelopes (especially is you're not using actual cash). If you have leftover money at the end of a cycle, then you can roll it into the next cycle or put it into your savings.
How this helps long-term spends/yearly spends
This, for me, has been one of the greatest advantages of envelope budgeting. I pay car insurance yearly and it is often easy to overlook and not really think about it, until it's too late and you suddenly have a large payment to outlay. Before envelope budgeting, I used to whack this on a credit card, not pay it off fully and then end up paying it off in subsequent months along with the credit card interest on top.
Envelope budgeting allows me to make an 'accrual allowance' every month where I put away a little each month. By the time the insurance is due, I already have the necessary funds to cover it. Say the insurance is £318, I just need to 'accrue' £26.50 every month. This is a lot easier to outlay then getting hit with a £318 bill with no money pot for it...
WAIT! It doesn't just stop here!
Your budget is an ever-growing and evolving part of your personal finances so don't see it as a one-time, box ticking task. There will be new expenses to account for as circumstances change in your life. Similarly, your income could decrease (or hopefully increase!) as well and these things DIRECTLY affect how much you can put in each envelope.
Make sure that you continually revisit and review your envelope budgeting system, to ensure that it's still meeting requirements and reaching your expectations of money. Things to consider as part of your review could be:
- Has your income increased or decreased since last check-in?
- Are there areas where you have overspent and had to cover with another envelope?
- Are there areas where you spent less than you anticipated? If so, can this stay in this envelope or can you move it to a long term goal or investments?
- Are you on track with your short term and long term goals?
Envelope Budgeting in software
Much like most things, everything seems to be shifting to digital/software based solutions. And it's no surprise that this shift brings a lot more benefits and automation to an envelope budgeting system. I still use this method and I simply do not know how I'd be in control of my finances if it wasn't for You Need A Budget (YNAB)
This online software has revolutionised my budgeting system hands down. YNAB uses virtual "envelopes" to represent budget categories and to show spending activity and balances for each category.
Not only that, but YNAB relies on four fundamental rules:
- Give Every Dollar a Job
- Embrace Your True Expenses
- Roll With The Punches
- Age Your Money
I'm sure at some point I will do a full blog post on YNAB but it's definitely worth checking out.
Other notable mentions are Honeydue, EveryDollar, and GoodBudget. I'm sure there are more but I initially trialled YNAB and haven't looked back since.
FAQ
Q. What if I spend all of the cash?
A. The goal is defined in YNAB's most important rule of "give every dollar a job", so the idea is to 'spend' all of the cash. Spending cash can also mean 'spending it on your future self' either in savings, investments, or towards a long term goal.
Q. What if I want to use a debit card or shop online?
A. If you've used your debit/credit card for convenience, you will need a spreadsheet or logbook to write down these entries in order to track this money. If you have an envelope written out for a category that you will ONLY use a card for, then leave it in your account and log it instead of using actual cash.
Again, with the digital world growing, I HIGHLY recommend spending time looking into using You Need A Budget (YNAB) for this entire budgeting system!
Make sure that every single penny has been assigned a job. This will give you an indication of whether you have enough to cover the jobs that your money needs to cover. If you do not have enough to cover the first two categories listed above (fixed and living) then you need to see what you can instantly cut down on to ensure these are covered. If you spend all the cash, this at least means that you're not spending more than you can afford.
Q. What if I have leftover cash at the end of the month?
A. This is great! This shows that you've gained in net worth so it's time to celebrate (within moderation!). This budgeting method can seem restrictive, so it's nice to reward yourself now and then with a dinner out or something. The option here is to use this to your advantage and get further ahead next month. Maybe you can roll this money over to the following month to give yourself a head start.
Q. What if I run out of cash in one of the envelopes?
A. This isn't so good... There's a couple of options here: 1. You simply have to suffer the fact you've run out and will have to cut back on spending. If you ran out of money in your "take-aways" envelope, well sorry but no more take-aways until the next payday. If you've run out of a critical envelope like "Electricity", but you have money sitting in a long term goal, then you can 'borrow' money from that envelope. This isn't something you want to be doing as a habit, it's only to get out of a sticky situation...
Q. So I can borrow money from other envelopes?
A. The answer, really, is no. Effectively, you're moving the goalposts here to what suits you which isn't how budgets work. If you're consistently borrowing from other envelopes, you may as well operate from one big envelope and dump all the cash into it. Strict discipline will help you learn quickly where your strengths and weaknesses within your budget lies.
Q. I have a question you haven't answered! How do I get my answer??
A. No problem! Feel free to reach out to me by clicking here or leaving a comment below.
