How To Set Up an Envelope Budgeting System

Learn to set up an envelope budgeting system.
Photo: Les Cunliffe/Photolibrary/Getty Images

One of the easiest ways to track your spending is to switch to an envelope budgeting system. While this may seem like a trendy new way to manage your daily budget, it's actually a system that's more than 100 years old. Most likely, your grandparents used this system or one similar to it.

Here's how it works: You divide up all your discretionary spending into envelopes by category. So one for eating out, one for groceries, one for clothing, one for miscellaneous spending, etc.

Generally, you would not pay your bills via this system; rather, you'd continue to pay them out of your checking account via direct debit. However, to make the envelope system work for you, you should stop spending stop using your checking account except to pay bills.

Read on for other tips and tricks on how to make an envelope budgeting system work for you.

Decide the Categories You Will Switch to Cash

Before you start the envelope budgeting system, you'll need to create your budget. Then you will need to determine which categories you are going to switch to the envelope system. Pro tip: these categories should be any line items that involve discretionary spending.

Common categories that are used are groceries, eating out, gas money or cab fare, entertainment categories, fun money, clothing costs, and household expenses.

Withdraw the Cash at the Beginning of the Month

The next step is to add up your discretionary spends and make a withdrawal at your bank for the total. Generally, it is best to write a check and request the required denominations you need for each category. For example, if you're allocating $25/month for household items, you'll need a twenty and a five dollar bill in that envelope. Remember, no "borrowing" from other envelopes!

Organize Your Envelopes for Each Category

Then, you'll label your envelopes with the categories and monthly allotted spend, then put the correct amount into each envelope. Find a safe place in your home to store your envelopes, and remember not to carry them with you at all times.

While it's never a good idea to carry a large amount of cash, you may want to get into the habit of carrying $20 in cash with you at all times to cover unexpected expenses or any potential spends at a cash-only business.

Take the Envelopes With Your When You Shop

When you go shopping or to have fun, take money from the appropriate envelope. You do not want to take the whole amount with you, because you will be more likely to spend it all. This is especially true for your food and entertainment categories. So take what you'd like to spend on that particular outing, then when it's gone, it's gone.

Afterward, put the receipts in the envelopes so that you can track your spending at the end of the month. This may help you notice spending issues and identify problems areas, such as shopping or eating out.

Stop Spending Money as You Run Out of It

The most important takeaway with the envelope budgeting system is that when you run out of money for one particular envelope, you have to stop spending in that category. This is why this budgeting system is so impactful – it helps you stick to your budget without running out of money each month.

Another plus, if you consistently run out of money in one envelope each month, that may show you that you have a budgeting or spending issue in that category.

Roll Left Over Money to the Next Month

If you have money leftover in the categories, you can choose to roll it over into the next month. This may work for some categories like groceries, so that you can stock up where there is a good sale or when you are saving up for something more expensive.

You may also splurge with extra money, use it to pad your emergency fund, or put it toward one of your long-term financial goals

Other Tips:

  • Divide some categories into weekly amounts. You can create sub-envelopes for weekly expenses so you do not spend all of your money at the beginning of the month. This works especially well for categories like your groceries. This way you know you will have some money at the end of the month so you are not just eating ramen.
  • There are benefits to spending cash. People tend to spend less when they must count out the cash when shopping, while they tend to overspend if they know they are using a credit or debit card. You may find that your spending goes down when you are using this method. 
  • Shop with a specific list and estimate your costs before you go into the store. In addition to a shopping list. you can use the calculator on your phone to track what you have spent. This can help you stick your budget, especially on big shopping trips like the grocery store or when you go to a bulk store to stock up on supplies. You can estimate the costs of the items on the list before you go to the store to help you stay on track. 
  • Consider using a billfold or coupon organizer for your cash. If you do not want to carry around envelopes, these are good alternatives. You can find them in office supply stores.
  • Leave your cards at home. If you know you will be tempted to dip into your checking account when you are shopping, leave your cards at home. This will force you to pay more attention to your spending when you are at the store. You can use the calculator on your phone to track your total before you get to the checkout.

Updated by Rachel Morgan Cautero.

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