If you’ve ever tried budgeting, then you already know how difficult it can be to stay within the limits you’ve set for yourself. The reality is that it’s just way too easy to ignore those boundaries and overspend – especially if you have a habit of using credit cards for the majority of your purchases.
This is why for some people, a better alternative is to go completely old-school and work strictly with what they can touch and see right in front of them: cash! In this post, I’d like to introduce you to a method called the cash envelope budget system and talk about its pros and cons.
What is the Cash Envelope System?
A cash envelope budget system is when a person manages their monthly expenses by making all purchases with physical money. This involves taking money out of the bank as they get paid, filling up a series of envelopes representing each of their expenses, and then only spending the money that’s in each particular envelope.
Many people associate the cash envelope system with financial guru Dave Ramsey. Although he did not create it, he did promote the method among his followers and it’s grown in popularity over the years thanks to its simplicity and effectiveness.
How Does the Cash Envelope Budget System Work?
Using a cash envelope system for budgeting is a fairly straightforward process. Here are the steps involved.
1. List Your Expenses
First things first, to make a budget you’ll need to know what you’ll be spending your money on. These will typically be your major expenses such as:
- Rent / mortgage
- Car payment
- Cell phone
To get started, go through your bank or credit card statements and write down each of the major ones. For all of the smaller expenses, you can make a “Miscellaneous” category to use as a catch-all.
2. Determine How Much Money You’ll Need Each Month
With your list of expenses, write down how much you’ll need for each one. For some, this will be easy since the cost is probably the same amount each month. But for others, you may need to come up with an average figure. If you do, be sure to add a little safety buffer so that you won’t come up short.
3. Fund Your Envelopes
For this step, you’ll need a stack of envelopes. On the outside of each one, write down the name of the expense and how much money should go into it each month.
If you haven’t already, go to the bank and get the cash you’ll need to fill these envelopes. Be sure to ask for a combination of large and small bills so that you can get as close as possible to the figure you’ll need for each.
4. Spend the Cash
As the month progresses, take cash from the envelopes as needed for your expenses. For purchases you make weekly, it may be helpful to break up your number so that you’ll pace yourself. For instance, if you’ve allocated $800 to groceries for the month, then set a limit of $200 per week.
Try as hard as you can not to exceed the limit you’ve set for yourself. If you don’t spend all of the money you took out, then put the leftover funds back in the same envelope.
5. Regularly Refill Your Envelopes
When the next month rolls around, repeat the process of withdrawing cash from the bank and funding your envelopes.
At the same time, take a snapshot of your progress. If you’re regularly finding you have excess cash in an envelope, then perhaps you can lower its limit and reallocate those funds towards something else. On the flip side, if you’re depleting it prematurely, then you’ll definitely want to take a closer look at this expense and see what further action is needed.
Pros and Cons of the Cash Envelope System
There are a lot of reasons why the cash envelope system has become such a trusted method for some people. But it’s also a system that has some drawbacks. Here are the good and the bad to using this method of budgeting.
- Simplicity – In terms of budgeting, it doesn’t get any easier than cash. All a person has to do is break up their income into physical paper bills and then set a goal not to spend more than this before the month is over. No fancy spreadsheets or math required!
- Transparency – Because you’ll actually use physical cash for each transaction, you’ll be more intimate with your money and where it’s going. That’s going to make it hard for unnecessary purchases to sneak their way and sabotage your budget.
- It’s effective – People who use the cash envelope system love it because they can see the money right in front of them, and so they know to pace themselves or face running out of money. On top of that, buying things with cash is much harder than it is with a credit card because of a psychological phenomenon called “loss aversion”. Putting those two things together, there’s a good chance that you’ll do a better job at staying within your limits.
- It’s incredibly tedious – It’s a lot of work to physically get cash from the bank, divide it up, and make sure each envelope is properly accounted for every month.
- It’s not digital friendly – Let’s be real … nearly everything these days requires a credit card. People who want to only make purchases using strictly cash are going to find it very challenging to do so.
- Major security problems – Stuffing envelopes with cash means you’re going to have a lot of loose cash in your house and on you in person when you leave the house. Considering how easy it is for physical money to be lost, stolen, or destroyed, this may not be a smart idea.
Who is the Cash Envelope System Right For?
If you’re someone who’s struggled in the past to follow a budget or track your expenses with a spreadsheet, then a cash envelope system might be a good fit. It’s simple and easy to execute. But will require some work on your part to make sure that it’s properly funded.
On the other hand, if you’re used to credit cards, comfortable with technology, and would rather not have the hassle of dealing with cash, then consider a more modern approach to budgeting such as an app like Buxfer. Similar to an envelope system, Buxfer lets you set limits for yourself in several major expense categories. However, the difference is that you can then use your bank accounts and credit cards like normal while the app syncs with this data and keeps track of everything for you. At all times you’ll have a real-time report of how you’re doing so that you’ll know if any adjustments need to be made.
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