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How to Use the Cash Envelope System

person holding an envelope with cash that they're using for the cash envelope system of budgeting

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The cash envelope system is an old yet effective system to help improve your budgeting skills. It’s been working for decades and remains an option for those wanting to control their finances. Modern tools make this system more accessible than ever. In this post, you’ll learn how the cash envelope system works and be able to evaluate if it works for your budgeting needs.

How to Budget Using the Envelope System

The cash envelope system is easy to follow. You have different envelopes that represent each of your needs within the month. Then, you place cash into these envelopes depending on your allotment. The allotment will consider your priorities and how much you generally spend on these categories.

While this system traditionally used literal envelopes, there are ways to modernize it if you prefer. For example, you can create separate categories in your bank account or other online wallets. You can also create several bank accounts to store your money for each. Separating them into envelopes makes it easier for you to see how much you can spend on each.

By creating this limit, you ensure that you don’t overspend on one category. For example, you may see yourself spending too much on food or leisure. You can try to limit your spending by putting a cap on the envelope, which means having a limit to how much you can put in and spend.

Of course, not everyone is the same, meaning that budgetary needs will vary from person to person. However, there are some common categories to consider. Here are some examples:

If you need to save more money for something, consider having a higher budget for that envelope. You can adjust the budget for each if you find that you’re hitting the limit on one category and going under it for another.

You can also adjust it based on changing circumstances. If someone has a child, for example, they might need to spend more on groceries and less on entertainment and leisure.

In short, the envelope system is flexible. You can customize it to suit your needs and adjust it anytime those needs change.

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Create a Budget Using Current Expenses

One thing you need to get out of the way first is your current expenses. These are your non-negotiables. These include bills, obligations, and other payments you need to fulfill every month. Here are some of the most common things you need to pay monthly.

  • Rent or mortgage
  • Car payments and gas
  • Student loans
  • Transportation costs
  • Insurance
  • Utilities

First, get money from your total monthly income to identify what you have left to spend. Then you can begin filling the rest of the categories. Remember that you don’t have to put all your money into these categories right away. You also don’t have to be afraid to put a little extra into each envelope.

It will give you more leeway for spending for each. You also don’t need to spend everything in the envelope either. If you have some money left over for the category, you can carry it over to the next month. Another option is to put it in your savings, which is a step towards a more financially secure future.

Also, take note of how much you’re spending on your essentials. Ideally, you want it to cover no more than 50% of your total income. If you find that you’re spending more than that, you may need to lower spending in any way that you can or find a way to increase your income. Cutting unnecessary obligations like recurring payments for services you no longer use can help in this regard.

Create Categories and Limits for Them

Once you have the current expenses set, now is the time to create other categories to fill up with your remaining budget. Here are some of the most common options:

  • Groceries and food
  • Personal care
  • Lifestyle expenses (Dining out and other social activities)
  • Pet care items
  • Children’s items
  • Clothing

Make sure to label each envelope so you don’t lose track of each category and your limits. Setting a limit will help you prevent using more money other than the allotment. You don’t have to be strict and overthink how much you need to put in for each. Gather an estimate of how much you spend and allot accordingly.

If you think you’re overspending, then cut down on a budget of one and put it into another. You can place a hard cap cash limit on it or a percentage. It all depends on your preference. For example, for one month, you could put:

  • $400 on groceries and food
  • $100 on personal care
  • $200 on lifestyle expenses

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Use Physical Envelopes for Cash

You will likely settle most of your bills online through a portal or your bank’s website. You may also have an automatic debit set up for some of your monthly payments. Either way, many of your expenses most likely involve using digital means rather than physical ones, but using physical cash also has its advantages.

For one, it’s easier to place the cash on envelopes. When you want to spend something on a specific category, you open the envelope and only use the money there. You won’t have the temptation to spend more, and you also don’t have access to your entire account. It can build discipline over time.

Only Use Cash in Each Envelope for That Specific Expense

Whatever cash is in that category, that’s your limit. If you spend all the money in the envelope, you won’t have anything left for that and will have to wait on the next refill. The limit helps keep you in check. You’ll eventually realize that you don’t need to spend too much on what you’re overspending on.

Alternatively, you’ll learn to be a little more frugal and creative with your money. You start to see offers that get you more value and begin researching more affordable alternatives to what you’re currently used to.

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Keep Your Envelopes In a Safe Place

Cash is valuable, and if you’re using an envelope system, you’ll have more than the usual amount inside your house. The best way you can keep them safe is to invest in some form of protection. Other than hiding it in your home, you can get a secure safe to store the envelopes. If you’re not comfortable having them inside your house, then try to find a way to store most of your cash away from home, like in separate bank accounts.

You don’t need to bring all your envelopes with you for the entire time. For example, if you plan on only going grocery shopping, then your grocery envelope should suffice.

The Pros of the Cash Envelope System

The cash envelope system can teach you more about financial control and budgeting. With one in place, you can avoid getting into debt and overspending on a specific category. In today’s world, it’s so easy to go over your budget, especially with the convenience of credit cards. Without conscious spending, you could end up using most of your money without realizing it.

If you’re planning on using literal cash envelopes, you should know that those who use cash tend to feel more of a connection to what they’re holding. Because you know that it’s physical and valuable, you’ll be more inclined to think about purchasing decisions before making them. Several studies have proven that those who use cash tend to use it less than a credit or debit card.

The Cons of the Cash Envelope System

By committing to a cash envelope system, you are removing yourself from many conveniences. Every time you need to refill the envelope, it means you have to spend some time at the bank or ATM to withdraw. You can spend too much time if it’s a busy day at these locations.

Having cash on you can also leave you vulnerable. Items like cards have safety precautions in case of theft. You can call the card company and shut the card down, so no one uses them. On the other hand, cash is accessible, making you vulnerable.

For the envelope where you’ll keep the most money, it’s best to keep it somewhere safe, like a savings account. That way, if the worst should happen, you’re still able to pay for essentials each month.

Who Does the Cash Envelope System Benefit the Most

The cash envelope system teaches you how to budget and helps you work towards your goals. The system works best for those new to managing their money in a stricter sense. You have a better idea of where your money goes and how much you can save each pay cycle.

You lose some benefits of having the money ready at the bank. You won’t be able to use your cards often, and the money in the bank doesn’t accrue interest while it’s with you. You can use savings or investment vehicles to keep larger chunks of money you won’t be using right away.

That way, you can have the best of both worlds. Part of your money is safe and growing while you have accessible cash to use for all necessary spending to keep you up and running.

If you’re too impulsive with your money, the cash envelope system can also help you. It will give you more control over your money and set you up with a system that can lead to fewer unwanted purchases.

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Can I “Borrow” Cash from Other Envelopes?

Borrowing money from other envelopes largely defeats the purpose of the cash envelope system. You use the envelopes to control your spending and ensure that you’re not using money for other things. If you find that you may have underestimated your spending on one category, then you can adjust for the next time you put cash in the envelopes.

Of course, if it’s absolutely necessary, you can borrow cash from other envelopes. The main issue with this is if you make it a long-term habit. In general, it’s easier to make justifications for borrowing once you’ve done it a few times before. You might want to set up a borrowing limit or only make a choice to borrow if it’s an emergency.

What Do I Do If I Spend Off All Of The Cash?

When you spend more than necessary, it may not necessarily be a bad thing. You can figure out spending habits you didn’t realize were there all along. For example, you may find that you’ve been spending too much on nights out or alcohol. By cutting down a portion of it, you can save more money on your envelopes in the future.

Sorting through the envelopes will also reveal how little you need to spend on categories. The money you use up can be for savings or fill up other areas. You’ll discover that there are many ways to work off the envelope system. The key is maintaining your long-term discipline with the envelopes to cultivate good spending habits.

Download a FREE Home Budget Template

Budget your money and track your spending with this fully responsive budget spreadsheet.

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Is There An Online Alternative to the Cash Envelope System?

With technology, there are alternatives you can now use instead of envelopes. The easiest would be to have apps made to mimic the same outcome. They have budgeting and savings features that help you work towards your goals.

Some online banks also allow you to create multiple checking and savings accounts. You can make each account into an “envelope” and have one account dedicated to car payments and another for rent, for example. This usually works best if you only have a few spending categories.

Ultimately, using an app will depend on your preference. If you don’t want cash on you, then it is a better system. Some have a better feel for finances when they have money, while others don’t.

Wrapping It Up

The cash envelope system is an effective way to encourage good budgeting and spending habits. It’s an old system, but one that is still effective in teaching these principles. However, the key to it being successful is discipline. You’ll want to stick with your envelopes and your limitations with them to be successful with it.

If you can manage that, you might find that it can work wonders, as many people have experienced. It isn’t for everyone, but it doesn’t hurt to give it a try.