I love envelope budgeting. I think it is by far the best budgeting system out there and there are so many reasons why.
For anyone who is scratching their head, envelope budgeting is a budgeting system that uses multiple different ‘envelopes’ to track spending in different categories.
Envelope budgeting was created in the times of cold hard cash and snail mail.
At the end of the month, you would receive your wages, usually in cash, in a little brown envelope from your boss.
People using envelope budgeting would then divide their cash into many different envelopes, each one with a different purpose.
As an overly simple example, you might get paid $1,000 per month and put $300 in your rent envelope, $100 in your utilities envelope, $200 for food, $100 for travel and $100 for entertainment. The remaining $200 can be saved or invested.
When you spend money in a certain category, the cash comes out of that particular envelope. So when your rent bill comes in at $300, you take the cash out of the rent envelope and hand it over.
Other bills are not quite so predictable and this is where envelope budgeting comes in really handy. Let’s say that your food bill for the month was $180, but you had $200 in your envelope. This means that at the end of the month you have $20 left in your food envelope.
With envelope budgeting, you can choose what to do with that $20. There are really 4 different things you can choose to do:
As the world of internet banking started to emerge, some people took their envelope budgeting online. They often opened a ton of checking accounts – one for each envelope.
This was ok in principal, but meant that you had a very messy financial life with 20 debit cards and cheque books!
Now, fortunately for us, gone are the days when you needed to have 20 paper envelopes stuffed with cash sitting in the drawer or 20 different bank accounts.
There are now many banks and apps that support envelope budgeting from within a single account, meaning you can have all of the benefits with none of the drawbacks.
We live in a time where technology can make envelope budgeting super simple and I think there is no reason not to give it a try.
Here are the 5 reasons why I think envelope budgeting is the best:
We all know that life happens. The best laid plans don’t always, well, go to plan.
Sometimes the car breaks down, sometimes we have an unexpected medical bill. Sometimes we just want to spend a bit more than we budgeted!
Envelope budgeting takes care of all the uncertainty in life. If you have some bills that are variable and unpredictable, then you can add money to an envelope and spend it when the times comes. Car repairs are a great example of this.
We all know they are going to happen at some time (unless you don’t own a car, which is an option), but it is difficult to know exactly when and exactly how much they will be.
In this case, you can use envelope budgeting to help.
Start with a sensible monthly budget amount (you can look at last years car repair bills and divide by 12 for a good starting point) and then you add this amount to your envelope each month.
When the repair bill comes in, hopefully you have enough in your envelope and you can simply pay the bill. But even if you don’t have enough, envelope budgeting is right at hand to save you.
If you have excess money in another envelope, this can be transferred over to plug the gap. Perhaps you have some left over money from the grocery shopping that can help.
Alternatively, you could ‘borrow’ the money from another envelope and then pay it back when the car repairs envelope gets topped up. So for example, you could take $30 out of your entertainment envelope to pay the repair bill, but then replenish this money when the car repairs envelope fills up again a few months later.
Ok, so let’s say you have reached the end of the month and you have $20 left in the grocery envelope, $30 in entertainment and $25 in Utilities.
The great news is you can now decide how to use that extra money. You could just leave it to roll over and enjoy a bit of extra budget the following month.
You can choose to transfer the excess to a different envelope or (my personal favourite) you can save or invest the excess at the end of the month.
This should only be done with bills and expenses that are either totally discretionary (entertainment) or bills that are relatively predictable and regular (utilities, property tax).
For things that are less predictable (like car repairs in the example above), the money should always stay in the envelope and be rolled over to the following month.
I used to feel super excited about making a new purchase. I would run home from the store, rip open the packaging and start enjoying my new purchase (probably a gadget of some description knowing me).
A week or so later I would then start to get buyers remorse.
Did I really need that? Could I have found it cheaper? Should I return it to the store?
With envelope budgeting, I don’t get those feelings anymore. If I have budgeted $50 a month for gadgets and I have been saving my $50 up for some time, I don’t mind if I go and spend $600 on a new iPhone. It was in the budget and that is what the budget is for.
Although you should focus on having a really high savings rate, I do believe that money should be enjoyed along the way as well!
This only works so long as you ‘pay yourself first’ and make sure that your savings and investments are paid, before you start to allocate money for gadgets and other luxuries.
Looking back over my previous budgets and finance sheets, I can see that I used to spend well over $40 a month on lunch and coffee at the office.
When we switched to envelope budgeting a few years ago, we decided that I was going to budget $30 a month for lunches at the office.
The funny thing is since starting to use envelope budgeting, I have actually been spending much less – averaging around $20 per month – that’s half what I used to spend.
Nothing else has changed, I just put this down to being more intentional and deliberate with my spending.
The other factor in my lack of spending is that if I underspend in one category, I can either spend this money in another area or add it to savings or investments. I prefer to do the latter if I can!
Every so often, we will have a monthly spending challenge, where we try to spend either nothing or very little in a particular category for a month or so.
Not only does this give a particular envelope a ‘rest’ (this can be great after an expensive time like the holidays – we often try to spend nothing on entertainment in January for example. That’s not to say we have no entertainment – just that we don’t spend anything on entertainment), it also makes you get creative with your spending (or lack thereof).
It is amazing what you can pick up for free or very little money when you begin to look at the deals and coupons that are available.
These little spending challenges are also a great way to learn how little you can live on when push comes to shove – perfect motivation if you have a 9-5 you are trying to leave behind!
So there we have it – 5 reasons why envelope budgeting rules.
If you need some help with your envelope budgets, you should grab my Financial Freedom Planner Bundle. It includes a full template for your very own envelope budget – just tap in your own numbers!