If you’ve ever read an old-school personal finance book, you’ve probably heard of the cash envelope system. Keep reading as I discuss this system, how it works, and why it’s still so effective in the age of online budgeting tools.
What is the cash envelope system?
The cash envelope system is a budgeting strategy. It involves taking the following steps each month.
Step 1: Identify budget categories that need envelopes
You don’t need an envelope for every single category in your budget. Rather, you may find it preferable to focus on the categories in which you typically overspend.
Here are a few commonly problematic categories to consider:
- dining out
Still not sure which categories to choose? Check out this article about organizing your finances. In it, I show you how to begin tracking your expenses with Mint. Doing so will highlight budget categories in which you frequently spend more than intended.
Once you’ve identified your target budget categories, you’ll need one envelope for each one. Write each budget category’s name on its respective envelope. Not sure which envelopes to use? Keep reading; later in this article, I’ll share some products that were specifically designed for the cash envelope system.
The budget categories you choose don’t necessarily have to be those in which cash is a valid payment option.
For example, you could dedicate an envelope to online shopping. You would just need to write the amount of money allocated to that category on the envelope (as opposed to placing cash inside of it). Whenever you make a transaction in that category, you’d just need to update that amount accordingly.
Step 2: Fill each envelope based on your monthly budget
Next, place enough cash in each envelope to cover your spending in its respective category for the current month. If you’d like to spend no more than $500 on groceries each month, for example, place $500 in the envelope dedicated to groceries.
If you don’t have enough cash to fill the envelopes all at once, that’s fine. Just place money in the envelopes as it becomes available. If you get paid twice monthly and have a $500 grocery budget, for example, you’d place $250 in that envelope two times each month.
As mentioned earlier, for budget categories in which digital payment methods are unavoidable, write the amounts on those envelopes. You don’t need to place cash inside those envelopes.
Step 3: Whenever you spend money in a target category, take it from the corresponding envelope
Every time you go grocery shopping, for example, pull money from your groceries envelope and bring it with you. For online transactions, simply update the remaining balance written on the envelope.
When deciding how much money to withdraw from an envelope, take into account how long it’ll be before you can refill it. You don’t want to end up with a prematurely empty envelope.
Step 4: Once an envelope is empty, you’re done spending in that category until the next refill
Under the most conservative interpretation of the cash envelope system, you can’t spend any more money in a particular category once its corresponding envelope is empty. You can only resume spending in that category when it’s time to refill the envelope.
A more liberal interpretation of the cash envelope system says you can take money from other envelopes if you’re really keen on spending in a particular category.
Either way, the key is that you aren’t allowed to accommodate additional spending by inflating your budget. Even if you reallocate funds between envelopes, you can’t spend more than originally intended.
Step 5: Decide what to do with any money left over at the end of each month
Occasionally, you may find yourself with money left in your envelopes at the end of the month. Decide ahead of time what to do in those scenarios. For example, you could roll that money into the next month or let yourself spend all of it.
If having lots of money left in your envelopes at the end of the month becomes a regular occurrence, however, look into allocating your money better. Some of that cash can go towards long-term savings or debt repayments.
Benefits of the cash envelope system
Next, let’s explore the benefits of using the cash envelope system to get your spending under control.
It forces you to confront your spending
Having to remove cash from an envelope whenever you’d like to spend it will force you to think carefully about each transaction. You’ll be conscious of the fact you’re about to shrink a limited pool of resources (the cash envelope you’re withdrawing from).
This isn’t the case with a credit card. Your credit limit likely exceeds what you’d spend in a single month. Consequently, it’s very easy to make excuses and overspend on credit. This isn’t possible if you follow the cash envelope system’s rules properly.
It compartmentalizes your money
Placing cash in separate envelopes that represent various budget categories will help you better compartmentalize your money. It’s a much more tangible approach to budgeting than the typical approach of working from a single checking account.
It harnesses powerful and well-studied psychology
Research shows people are typically willing to spend as much as 100% more when paying with credit compared to cash. It makes sense. When you pay with cash, you go through the experience of handing money over knowing you won’t get it back. Credit (and even debit) cards mask this experience. You don’t see the money leaving your possession. All you’re doing is tapping a card.
The cash envelope system harnesses this psychology by forcing you to pay with cash more often. You’ll likely find yourself spending much less.
You don’t need to be a spreadsheet wizard to budget effectively using the cash envelope system. In fact, the cash envelope system originated long before personal computers were widely available. It’s a beautifully simple budgeting strategy even a child could understand within a few minutes.
It adapts well to the modern financial landscape
While cash’s popularity as a payment method is waning, the cash envelope system isn’t becoming obsolete. In fact, it adapts quite well to digital transactions using the method I described earlier (writing amounts on the envelopes rather than placing cash inside of them).
Downsides of the cash envelope system
While the cash envelope system’s benefits far outweigh its cons, no budgeting system is perfect. Here are a few downsides.
Many stores no longer encourage cash as a payment method, particularly in a post-COVID world. Even ignoring that, however, you’ll still likely find the cash envelope system inconvenient. Pulling cash out of envelopes and periodically counting what’s left in each of them to ensure you’re not overspending takes time. This is especially true if you have a partner or anyone else who will also be pulling cash from the envelopes.
While that’s actually the point of the cash envelope system (making it challenging to spend money), you may find yourself less likely to stick with it than some other, more convenient budgeting method.
Keeping lots of cash on hand is risky
Depending on your budget, you may be withdrawing hundreds or even thousands of dollars in cash at once. That’s risky – especially if you have sketchy roommates, live in an area where break-ins are common, or misplace things constantly.
At the very least, I strongly recommend investing in a good wall-mounted safe and keeping all of your cash envelopes there. You can also check out my list of the 100 best places to hide money at home for more ideas.
You may find it hard to stay organized
There will always be parts of your budget that live online (i.e. pre-authorized car or home payments). Keeping those components aligned with the cash envelope system can be tricky. You may even find that withdrawing so much cash each month eliminates an important buffer that kept you from overdrawing your checking account.
To avoid this, you need to be aware of when money is scheduled to enter and leave your checking account. Make sure you always have enough of a buffer.
Tips for ensuring success with the cash envelope system
Here are some tips for making sure your experience using the cash envelope system is a positive one.
You don’t have to tackle every possible budget category with the cash envelope system at once. You can start with one or two pilot categories and build from there if you see positive results. In fact, you may even find that using the cash envelope system to control your spending in one or two categories is enough.
A major benefit of starting small is that you may find the cash envelope system less overwhelming that way. Consequently, you’ll be more likely to stick with it.
Don’t take an entire envelope shopping
When you go shopping, only bring the amount of cash you intend to spend on that trip. While it might be tempting to bring your entire cash envelope for convenience, this makes it too easy to overspend during a single shopping trip.
Put the money you save to good use
You’ll likely save money using the cash envelope system. Make sure you put that money to good use rather than simply adding another discretionary category to your budget and spending it there (which would defeat the purpose).
For example, consider investing the money. Even if it’s just an extra few hundred dollars per month, there are many ways to invest it. Check out this article I wrote highlighting a few options.
Evaluate your progress periodically and adjust course as needed
The cash envelope system isn’t a ‘set it and forget it’ budgeting method. Rather, the smart approach to incorporating this system into your lifestyle entails analyzing your results periodically and adjusting course as needed.
Here are some good questions to ask routinely:
- How much money are you saving by continuing to use the cash envelope system? Compare your spending in the chosen categories before and after you began using the cash envelope system. If you aren’t saving much (or anything at all), dig deeper into why.
- Are the categories you originally chose still relevant? Your financial needs and priorities will likely change over time. Make sure the categories you’ve chosen to target using the cash envelope system adjust as well to keep up with those changes.
- Are the amounts you chose for each category still appropriate? If you consistently run out of money in a particular envelope every month (or always have lots left over), take a closer look at the amount you’ve allocated to that budget category.
Use a dedicated cash envelope system kit
The cash envelope system’s popularity means there are several kits designed specifically for it. Here are some options you can purchase through my Amazon affiliate links:
- KASU Cardstock Cash Envelopes: Each envelope in this kit comes with a printed template you can use to keep track of transactions associated with it.
- Outus Budget Envelopes: This kit comes with 12 laminated cash envelopes and accompanying budget sheets for tracking your expenses.
- Kingovalley A6 PU Leather Notebook Binder Cover with 12 Cash Pockets: With this kit, you can keep your budget envelopes organized in a leather binder containing enough space for additional notes you might like to keep.
There’s a reason the cash envelope system has remained popular for several decades – it works! I hope this article has helped you understand not only the steps needed to implement the cash envelope system but also the strategies you can use to ensure a high likelihood of success.
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