Envelope budgeting is a very popular and very intuitive way to budget your spending.
I had heard the term used frequently but I never really understood what the whole envelope budgeting process was or why it was successful. In fact, I actually thought envelope budgeting meant that you were loosely tracking your spending on the back of envelopes or something like that (I was totally wrong!).
In envelope budgeting, you categorize your spending into broad categories and assign an envelope to each. You might have one for dining out, one for groceries, one for utilities, etc. You decide how much you will spend in each category for the month and put cash into that envelope. As you spend in the category, you take money out and return the change. If you run out, you must pull from other envelopes.
This forces you to spend within your means within a month because you can only spend the money that’s in those envelopes. It’s an extremely effective method of budgeting if you are able to maintain it.
Advantages of Envelope Budgeting
The reason why envelope works is because it makes people plan up front instead of winging it each month. It also restricts how much you can spend from both an individual category perspective (each envelope) and a monthly total perspective (all the envelopes). When an envelope runs out, you can only pull funds from another envelope, which limits how much you can spend each month.
It’s also a very simple system, making it easy to adopt and maintain. You don’t fill out fancy spreadsheets, there isn’t a complicated tool to learn, you just need envelopes.
Disadvantages of Envelope Budgeting
A disadvantage of envelope budgeting is that you have less information. You know you spent $500 on “food” last month, where can you cut back? Since you don’t track your spending, by default, you don’t know how much was spent on groceries and how much was spent on restaurants. It requires you to remember, rather than having a tool remember.
Fortunately, you can tailor any tool for your own needs. You can track month to month spending on the back of the envelope or you can stick receipts in the envelope to help track your spending. It’s a simple enough system that you can adjust it to fit your needs or capture the information you need.
Update: According to the comments, if you’re looking for an online version of this envelope budgeting system, Mvelopes offers this type of service (and they have a 30 day trial).
(Photo: evilpeach )