Envelope Budgeting: A Simple And Effective Method

The Envelope Budgeting Method

In the previous post, we looked at the benefits of budgeting. Here we will look at one of the methods used for budgeting: The Envelope Budgeting Method.
In a nutshell, it is about allocating money towards different categories. This method has been made popular in recent times by personal finance gurus.
Let us dive a little deeper into this to find out what the fuss is all about.

What is the Envelope Method?

It is a budgeting method that uses an envelope system to separate spending areas.
You can physically separate your money into separate envelopes. Each envelope is designated for a particular area of spending. Ex. Eating out.

How does the Envelope Budgeting Method work?

As a first step, figure the separate spending areas you have.

Typically these are the following:

1. Grocery & Household
2. Rentals and Utilities Payments
3. Vehicle-Related Expenses
4. Entertainment & Eating Out
5. Shopping
6. Miscellaneous
7. Savings (the most important one)
   

Now that you have the areas sorted, you make a separate envelope for each of the areas.

How to set up an Envelope Budgeting Method?

Let us do this in a step by step method to make sure we get it.

1. Figure your total income each month:

For those of us with a salary based single source of income, this is pretty easy. If you have more of a gig-based income then this might take a little effort. But figure out the total income from all sources and have that written down.

2. Figure your expenses from previous months:

Look at where you have been spending money over the past few months. Take the effort to segregate the areas of spending. You should be able to divide your expenses in to similar headings as above.

3. Categorize your spending:

You should create your own categories as relevant. Ex. if medication is a real expense because of someone at home, create a separate stream. Analyse your previous expenses to understand where you have been spending your money. Look for areas where you can cut down some of the expenses you might have had. Take a hard look to be sure you need to spend whatever you have.

4. Set up each envelope with a specific amount of cash:

Once you have categorized your spending, you can move to the next step of actual budgeting. Based on your analysis above, set aside a certain amount of money for each envelope. The trick that makes this system work is to put in the actual amount you need for each area in the relevant envelope. Ex. if Eating Out gets Rs. 5000 then put the 5000 into that envelope physically.

5. You can now spend the cash from each envelope:

The system works when you only use the money from the right envelope for your spending. Ex. if you are eating out then only use money from the eating out an envelope.
Once you have exhausted the money in that envelope then there should be no more spending in that area.

6. Keep tweaking your envelopes based on your monthly spending:

Of course, you might not get the system right on the first go. Keep tweaking it till you are able to set up the system such that it works for you.

7. The Savings Envelope:

This is the most important one. You put money into this envelope and don’t touch it at all. Even better, invest it wherever you have planned to invest your savings. This envelope should get a minimum of 10% of your earnings.

Envelope Budgeting Benefits:

While this whole physical money system might seem archaic to us in the age of digital payments, it works. Of course, you can use envelopes as a metaphor. You can create 6 different UPI accounts for managing your money. Spend only from the relevant one or not at all.
There is a reason this method has become very popular. It is intuitive, easy to implement and it works.

Some benefits of the envelope budgeting method:

• It can help you stick to your monthly budget
• You can see where your money is being spent. You know how much is left in each area.
• Gives you a clear picture of how much you earn, spend, and save every month
• Saves time when making an expense list because everything is organized in envelopes
• Helps you stick to your financial goals

Envelope Budgeting Drawbacks:

This is probably the simplest budgeting method. It is also very simple to set up and does not involve apps and fancy spreadsheets. However, there are some downsides.

• The cash in the envelope might dry up. If it is an essential envelope such as groceries – what do you do.
• It might be difficult to predict specific expenses for each envelope
• Sometimes you might even be tempted to spend more because there is cash left in the envelope.
• It works best for individuals with only one income stream. For those with sporadic incomes, it might need adjustment on the fly.

Final thoughts:

Now you have a grasp of the simplest budgeting method. The simplicity and ease of implementation are what draw a lot of people to this method. You can get started right away with this method for your own budgeting as well.

You can also use the above as principles and apply them in your own way, adapting them to a more digital world.

Some resources you could look at for more information on budgeting:

Ramit Sethi’s blog

Dave Ramsey’s explainer on envelope budgeting

The Balance on the same topic – I really like how The Balance is laid out and structured.

and finally a youtube video link for those more visually inclined, the budget mom.

Of course, I would also ask you to look around this blog and read on the very basics to start with.