What is the Envelope System?
The envelope method of budgeting has been around a long time. When I first heard about it, which was probably in the 1980s, it struck me as a great method for personal budgeting. What is the envelope system and why do some people still use it - and swear by it?
Even if you decide not to use the cash envelope method, it’s a really good idea to understand why it’s such a powerful personal budgeting technique. And, though it has it's challenges, I’ll explain how you can adapt the technique to modern times.
What is the Envelope System in a Nutshell?
Because the envelope system has been around a long time – much longer than the 1980s – it hails from a period before people had access to easy credit. Nowadays, envelope budgeting – also known as cash stuffing – still has fans. Some people swear by it as a means of getting a grip on their finances.
It’s a cash budgeting system. If you receive your wages in the form of cash, you divide that cash up into separate ‘piles’ to cover your expected outgoings for the month. If you get your income paid into your bank, you just go to the bank and draw it out as cash. Then you allocate it to your chosen categories. For example:
- Housing costs
- Food
- Clothes
- Transport
- Fun
- Long-term savings
- Debt payments
…and so on.
You then put your cash into separate envelopes, each envelope representing a different budget category. When you buy food you take cash from your food envelope, when you buy clothes you take cash from your clothes envelope. If you run out of cash in one envelope, you should not borrow from a different one. Each envelope represents a fixed budget with it's self-imposed spending cap: the amount of cash it contains.
Also, you never buy on credit. All your spending comes out of your cash envelopes or – in the case of major purchases – a bank account into which you’ve deposited your cash.
Of course, you don’t have to use envelopes for your cash. Any practical physical storage method will do. Jars, boxes, bags: it doesn’t matter.
What is the Envelope System Drawback?
Before we get onto the advantages of the envelope method of budgeting, let’s be clear about its challenges. Envelope budgeting was created in times when most transactions were conducted in cash. Also, when there were no credit cards or debit cards, let alone phone payments.
The rapid shift towards a cashless society means that there are major challenges to using envelope budgeting, at least in the way that it was used in the old days. I do use cash for my cafe visits. Other than that, the main reason I don’t use the cash envelope system is that it takes a lot of time and effort. For me, it's too fiddly.
When you receive your wages, you need to convert into the exact cash denominations to allocate to each envelope. For example, you may want $100 for one envelope and $375 for another one. So, you’ll be making a trip to the bank to procure the right mix of notes and coins.
Then, when you go shopping, you need to take the right envelopes: food, clothes etc. And when you receive change at the till, this needs to go back to the correct envelope. In some shops, this could involve a mix of envelopes.
And, at home, you’ll be investing time on your envelope storage and accounting. It’s detailed work. Added to which, you may have security concerns about a safe place to store your cash.
Also, some suppliers may not allow cash payments. For example, your mortgage provider may insist on direct debit.
So, cash stuffing is not an easy road. And yet it still has fans for whom the advantages outweigh the drawbacks.
Why Use Cash Nowadays? What is the Envelope System Advantage?
The key point about the cash envelope system is that you cannot easily go over budget. Or, at least, it’s like an alert system. If you overspend on a budget category, you have to take money from a different envelope to make up the shortfall.
So, the envelope system is a way of disciplining yourself to stay on budget. In the old days, if you ran out of cash you’d have to wait until the next day you got paid. Cash stuffing mimics that experience.
Of course, if you’re prudent, you will have an emergency fund you can draw on if there are unexpected bills. That’s no different from the old days, though. It has always made sense to have some savings you can fall back on, if needed.
For quite a while, I stopped using cash except at a few local stores that didn’t take card. But, recently, I’ve gone back to carrying cash for one of my budget categories: treats.
Treats is an area of spending where we have free choice – much more so than with necessities – and I like to think that using cash helps me spend my treats money on things I really enjoy.
Swiping a card is so easy that, unless you make a conscious effort, you hardly notice the amount. But with cash, you have to fish the correct amount out of your pocket or wallet. So, it can help you to be more mindful of your spending.
There are other strategies that aid this mindfulness. And there’s no doubt that increasing your awareness of where the money is going is a key technique to help your personal budgeting. Much of budgeting is to do with making conscious choices about your spending, rather than acting on autopilot.
You certainly don’t need to use cash envelope budgeting to achieve your financial goals. But it’s still very useful to understand what the envelope system entails, and why the principles are so effective.