According to Nasdaq, the U.S. average combined debt — mortgage, auto, personal loans, and miscellaneous debt — is just under $140,000 per household. Many experts recommend that families avoid the use of credit cards, and the envelope budget system, coined by Dave Ramsey, is a simple way to organize this undertaking.
What is the envelope budget system?
This practice is a cash-only budget that helps prevent overdraft fees, assists with more mindful spending, and aims to reduce credit card debt. To make the system work, designated cash is placed in envelopes for each budget category, like “groceries,” “entertainment,” etc. Only the cash in the envelope is spent on that category’s purchases and, when there is no cash left in the envelope, there are no more purchases. You don’t bail yourself out with your credit or debit card, you don’t “borrow” from other envelopes or from next month, and you don’t spend the cash in that envelope on anything but that category.
Envelope system categories cover day-to-day expenditure
One thing to remember is that this system is designed for discretionary spending. Mortgage or rent payments, utility bills, auto loans, insurance premiums, savings and investments, and other fixed payments are paid in the usual way; in fact, proponents of the system advocate setting those as automatic payments. Envelope categories vary from household to household, but some suggestions are:
- dining out/entertainment
- doctor/dentist visits
- household items/furniture
- gasoline or transportation
Experts suggest including the miscellaneous category as a sort of “mad money” category to help keep motivation stronger.
Setting up the envelope system for budgeting
Ordinary or manila envelopes are suitable for this method of budgeting, or specialty envelopes may meet cash-sorting requirements better. Some people find that color-coding the envelopes is more efficient for filing and access. Label the front of each envelope with the category title, and devise a way to record each purchase. One simple option is to glue a lined index card to the front of the envelope.
Determine how much money is assigned to each category and divide that amount by the number of monthly paydays and withdraw the appropriate amount of cash. For example, if $500 per month is allocated for groceries, and you’re paid twice a month, place $250 in the grocery envelope each payday. Use an envelope system organizer,or place the envelopes in a money bag. Remember that the cash in the envelope is for purchases, so keep the envelopes handy.
Make purchases with the cash and return the change to the envelope. Some people round the change to even dollar amounts and place coins in a savings jar or piggy bank for treats. If coins are part of your budgeting purchasing power, adding coin envelopes to the envelope system wallet helps keep them organized.
Accommodating online payments and purchases with the envelope system
Clearly, cash isn’t an option when buying online, but those electronic purchases can still fit within the system. One method is to use a debit card for the purchase, removing the cash equivalent from the envelope and depositing it into the relevant bank account. If online purchases are a regular happening for some categories, a dedicated prepaid debit card can replace the cash for that envelope.
Handling emergencies and tips for self-discipline
The miscellaneous category can serve as a backup source for emergency funds; it should not simply make up for overspending in other categories, however. In a true emergency, “borrow” from another category, but experts recommend discussing it with an accountability partner first, to be sure that there aren’t other options.
If you’re tempted to “borrow from Peter to pay Paul,” for general expenditure, only take the envelope that’s needed for the shopping expedition. Leave debit and credits cards at home if the tendency is to use them for extra, unplanned purchases.
The envelope system is a simple tool for gaining control over a budget, but it does take self-discipline, and, if budgeting in general is a new habit, it may take a couple of months to get the amounts for each category settled. One other benefit — putting all the receipts into the envelopes and recording them on the envelope or on a note inside means they’ll be organized and ready at tax return time.