I was hanging out with some readers on facebook last week and one of them asked, “What’s an envelope system?”  I searched for a link to my blog post all about envelope systems and you know what?  I never wrote one! I talk about them here and there, but didn’t cover the basics in much detail.

An envelope system is a cash system that makes sticking to a budget so easy a kid can do it.  Basic envelope systems have an envelope for each budget category with cash in it.  Some families refill the envelopes every two weeks.  We prefer to fill them one month at a time.  If you are living paycheck to paycheck, I recommend budgeting for each pay period.

However you do it, there are TWO important rules to follow:

1.  Don’t move cash from one category to another one without checking in with your accountability partner (your spouse if you have one.)
2. When you are out of cash, you can’t spend any more in that category until the next budget period.

Dave Ramsey includes envelopes for budgeting in his Financial Peace University kits, but any envelope will do.  If you want cute ones for cheap, you can print these and glue them together like I did for the photo.

Dollar Tree 7 Category Coupon Organizer

I don’t like using paper envelopes because it takes extra time to open each flap and get money out.  I’m often spending from more than one category at a store, so I prefer using a checkbook size coupon organizer that allows me to access all my categories at once.   They are available for $1 at Dollar Tree or the Target Dollar Spot.  The main downfall of these coupon organizers is their holey bottoms.  They work great for keeping bills together, but coins won’t stay in their proper slot.  I don’t worry about it and use loose change when it makes sense (like to give exact change to the cashier or for late month ice cream runs.) If this bothers you, there are more secure options.

Sturdy wallet options include: the 8 category Buxton Ultimate Shopper, available in pink, black or cheetah for around $10.  I don’t have this one personally, but it looks like the change might float in this one also.  BUT it has a zipper which will keep it from ending up in the bottom of your purse.

Or the 5 category Savvy Cents Wallet available in 7 colors for $32.95.  This one has a zipper change pocket in the back.

Etsy also has some cottage made versions including this $5 sewing pattern for those of you who love to DIY.

We don’t use cash for every category in our budget, only the ones that are easy to overdo.  For example, we use a debit card to buy gas for the car.  It would be a pain to take all the kids out of the car to walk into the store to pay every time we buy gas.  On our road trip to Colorado last summer we ran across some gas stations that gave a discount for using cash.  We made the effort to walk in and pay at those shops. We also don’t use cash for the electric bill, natural gas bill, insurance payments or our mortgage.  Those are all paid by direct bank transfer.

I have a Target Red Card (debit card) that I use for all my Target purchases.  It gives me an additional 5% off plus free shipping when shopping online.  When I use my debit card to shop from a category we’ve designated for cash, I immediately pull the cash out of the corresponding envelope and move it to an envelope to go back to the bank.  We generally hold this “bank” envelope until the following month and use it to restock our envelope system.  The exception is if we start to get low in the checking account I go ahead and deposit the cash to prevent an overdraft.

Benefits of an envelope system:

1.  You can see at a glance how much money you have left in each category.
2.  It prevents checking overdrafts.
3. There’s no huge credit card bill to pay off at the end of the month.
4. If you forget to write it down, you can still see how much money you have left.

Downsides of an envelope system:

1.  There’s no record like with a credit card.  So you’ll know the money is gone, but you might not remember what you spent it on.  (We keep our receipts and record them into Quicken as an extra accountability step.  If I weren’t married to a CPA I’d SKIP this step, but it’s really important to him.)
2. Risk of theft.  In the 11 years of living with an envelope system I’ve only be stolen from 1 time.  It was sad and a good lesson for me to keep a better eye on my stuff.  Some people  hedge against the risk by only taking a small portion of their budget with them when they shop.

Tips for making the envelope system work for you:

1. Let each spouse have his own set of envelopes, based on the spending they typically do.  For example, I keep most of the grocery money, the clothing money, and the gift money. While Darren keeps the date night money and a lunch envelope for buying his lunch groceries that he keeps at the office.
2. Get some small bills so you can make change for yourself if buying from multiple categories.
3. Make a new budget every month.  It can be based on the previous budget but you should make changes based on real life.  Are you throwing a birthday party this month?  Budget it.  Did the electric bill go up because you had to turn on the air conditioner, change it in the budget.  Is it time to buy half a cow or stock up on 50 pound bags of grain?  You get the idea.

Let’s keep the discussion going.  Do you use an envelope system? Put your tips or questions in the comments.

For more advice on starting a budget from scratch, try Create Your Monthly Budget