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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If you avoid using credit cards or simply want to return to using cash as your primary way of paying for things, then the cash envelope system might be right for you.

In this article, we’ll talk about a budgeting method that involves splitting your money into different categories and physically placing the money into envelopes or “buckets” so that you can better keep your spending under control.

Let’s jump in and talk about the cash envelope system.

What Is The Cash Envelope System?

The cash envelope system is a budgeting system where you physically separate your money into different envelopes representing spending categories ranging from required expenses like groceries to discretionary spending like streaming services.

This budgeting method can be helpful if you need a more visual budget or if you struggle with spending and need to limit yourself by using cash versus a credit card or debit card.

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Studies show that the average person will spend 83% more money when using a card versus when using cash, and this can make using the cash envelope advantageous if you worry that you have a spending problem or if you simply want to save money.

How To Use The Cash Envelope System

It’s important to note that your budget is personal to you, and you’ll have to decide how much money to allocate to each envelope as you develop this system. 

You may decide that some categories will need more or less cash as months go on. This is entirely normal as most budgets need to be adjusted semi-regularly.

What works for others may not work for you and vice versa, so feel comfortable knowing that it’s okay to take time to figure out the best way to design and implement your budget.

Here’s a walkthrough on how to start the cash envelope system.

Create a Budget

You’ll first want to create a budget that works for you. Using a pencil and paper, spreadsheet, document on your computer or phone, or app, write down all of your expenses by reading over your credit card and bank statements.

Using this information, you can figure out how much money you need to get by each month. If you’re able, consider adding 20% of your take-home pay as an expense to “transfer to savings,” which can be used to pay off debt, save for an emergency, invest for retirement, or used for any other significant savings goal.

A strategy you can employ is the 50/30/20 budget. This says to use 50% of your money towards needs, which include rent or mortgage, groceries, utilities, and work transportation. Then, 30% of your money is put towards wants, such as entertainment money. Lastly, 20% of your money is put toward savings.

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Categorize Your Spending

As you create your budget, categorize each of your expenses into buckets. For example, you might categorize your wants into buckets such as:

  • Eating out
  • Streaming services
  • Mobile games
  • Subscription boxes
  • Pet toys
  • Coffee money

Depending on what you do for fun, you can consider many other buckets for your discretionary spending.

Of course, make sure you can afford how much you’re spending in every category, and be sure to categorize your required living expenses as well. Those are the ones that include your rent or mortgage, car payments, credit card payments, student loan payments, and similar.

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Create Limits To Each of Your Categories

After you’ve determined that you can afford your budget, the next thing to do is to limit how much you’ll spend in each category or bucket.

Figuring out how much to spend in each category may not be an exact science. For example, you know what your rent or mortgage payment is every month, but you might not know how much to spend on takeout.

With this in mind, it’s okay to estimate how much you’ll spend in the first month and then adjust each month until you’ve figured it out.

But don’t use estimation as an excuse to overspend. Instead, do your best to underspend in every category that you can. Each month's leftover cash can be transferred to savings or used for other financial goals.

Label Your Envelopes

The next step is to get as many envelopes as you need and label them with each category you identified earlier.

This simple step shouldn’t take very long, and if you realize you need more or fewer categories, this is a good time to adjust.

Place Cash In Each Envelope Based On Your Limits

Once you’ve labeled your envelopes, place the correct amount of cash in each. The cash you place in each envelope is the amount you determined for the category earlier.

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After you place the money in the envelope, the cash in that envelope should only be used for that category of spending and nothing else.

To stick to your cash envelope system correctly, you’ll want to only spend money on a specific category from that specific category’s envelope. You don’t want to spend money from one envelope on another category’s expenses.

Adjust Each Month Until You’re Comfortable

Each month, decide if your budget for each category still makes sense. For example, you may realize that you’re spending more on your electricity bill than you originally thought. This could be true if you have electric heat, you’re entering colder months, and you are using the heat more.

What’s interesting about using the cash envelope system is that you may discover that you spend more money on certain things than you had thought.

Even after adjusting your budget for a few months, you may want to continue to adjust every so often as budgets change over time. Your income might increase, or your lifestyle may change, as two examples.

Examples of Envelope Categories

The cash envelope system is unique to each person who implements it, but if you’re looking for inspiration, here are some typical categories that you might expect to create based on your lifestyle.

  • Rent or mortgage
  • Groceries
  • Utilities
  • Transportation costs (gasoline, bus tickets, etc.)
  • Clothes for work
  • Clothes for going out with friends and family
  • Subscription services such as Netflix or Hulu
  • Mobile game in-app purchases
  • Eating out
  • Vacations
  • Toys and other gadgets for kids

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This isn’t an exhaustive list, so as you create your budget, you may come up with other ideas for your budget based on what makes sense to you and your household.

Pros of the Cash Envelope System

There are some distinct advantages of the cash envelope system, which include:

  • You’ll be more aware of your spending: When you use cash, you’ll be more aware of your spending as you see exactly how much money you have left in a given category as you use the money in the envelope. Additionally, physically holding cash and handing it over as you buy something may cause you to think twice about future purchases.
  • You won’t accidentally have an overdraft fee or sink into debt: Because you’re unable to spend more than you have, and because you are using cash and not withdrawing from a bank or swiping a credit card, it’s not possible to incur debt or accidentally get charged an overdraft fee when you use cash from one of your envelopes.
  • It’s not possible to make online purchases with this system which may make you less likely to shop for frivolous items. Because you actually have to go to a store to buy things, you may not make an effort to do so, stopping you from buying something you might not need and saving you money.

Cons of the Cash Envelope System

The cash envelope system isn’t without drawbacks. Here are a few of them:

  • It takes time to go to the ATM frequently, and carrying a lot of cash on you can put your finances at greater risk if you are a victim of theft.
  • Because you’re not using credit cards, you won’t have benefits such as fraud protection, rewards, and other benefits that credit cards offer.
  • It can be complicated to manage a budget for yourself, your partner, and even your children if you’re using cash envelopes. One solution to this is to sit down with your partner and work out a plan together.

Wrapping It Up

The cash envelope system certainly has its pros and cons and has merits for those with trouble controlling their spending habits or for those who simply want to avoid credit cards and debit cards.

Check out Clean Cut Finance’s home budget spreadsheet for assistance in creating a budget that’s right for you.

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