Methods to Budget and Save Money #1: The Envelope System

by Broke Professional on January 18, 2011 · 1 comment

The Envelope System: Household Budgeting, Old School Style

The importance of utilizing an effective technique for budgeting and saving money cannot be underestimated. Budgeting methods are the saver’s game-plan; the serious “budgateer’s” tools of the trade. Just like a carpenter would be lost without his tools, a saver will likely end up lost unless they find an effective method for saving money.

Introduction

There are a great many different types of budgeting and/or saving methods. There are even variations upon variations, and each method has its own outspoken disciples claiming they know the easiest way to plan your family finances.

Luckily, in today’s technologically savvy society, it is easier than ever to find effective ways to budget and save money.  The hard part might be narrowing down which method to use because of the proliferation of options.

What follows is the first in a sporadic series that will provide an overview of some of the budgeting/saving method tools out there.  This series will also touch on my personal experience(s) with each method, if applicable.

I will try to provide both a technological and a non-technological implementation for each option discussed.  I am hoping that I will receive a lot of comments discussing the pros and cons of the different budgeting systems, so please let me know your thoughts when your done reading the post.

The first budgeting method to be discussed in this series is “The Envelope System.”

The Envelope System

OVERVIEW

According to this Wikepedia entry, the envelope system is thought to have originated in the 1930’s, during the Great Depression.  This envelope method is, at its core a very simple budgeting method.  However, it can be modified to be either as simple or as complex as you desire.

Step 1: Essentially, a proponent of the envelope system would determine in advance each of their monthly expenses and the monthly breakdown required to save for additional future (non-monthly expenses), such as yearly premiums on life insurance or planning for a family vacation.  Monies earmarked for savings/paying down debt beyond minimal payments should also be accounted for as a monthly “expense”.

Step 2: The saver would then take their paychecks and allocate the proper amount of monies into each category and sub-category.  Proponents of the envelope budgeting method tend to focus on “necessaries.” Read here to see reader comments from Almost Frugal on the issue of the effectiveness of the envelope method.*

Step 3: Repeat.  Recalibrate/reallocate the system once in a while to account for financial changes.

ENVELOPE SYSTEM EXAMPLE CATEGORIES

Some examples of categories and/or subcategories that would fit into the category of necessaries include Grocery Bills, Utilities, Rent/Mortgage Payments and other monthly debt repayments, and Season Tickets to your Favorite Sporting Team (or so I have unsuccessfully tried to convince my wife).

The important thing to remember is that you can and should tailor this system to meet your needs.  Therefore you should remember to use the envelope system as a tool rather than a definitive system.  Some people include savings in the envelope system and some do not.  Others budget for wants as well as needs.  If a mortgage bill is due but there is no money left in the “mortgage envelope” then you should probably do what you have to do, and then fix what went wrong so such an issue does not arise again.

The important thing is to pick a system, think about how your money is being spent, and then allot a sufficient amount of resources to meet your goals and needs.

(Note: Mint.com is a site that can give you an idea of how you are spending your money.  If you feel comfortable with using their system, mint.com could act as a good primer prior to starting a new budgeting plan and give you a good starting point for each envelope).

The Envelope System: How to use it to Budget and Save Money

The envelope system will allow you to see exactly where your money goes.  You might therefore be able to find areas where you can make cuts from your budget.  Any budgeting system should allow you to save money in overdraft fees, late fees, loan interest, and other such expenses that can arise when you are not keeping a careful eye on your finances.

The Envelope System: My Personal Experience with the System

I remember every other Friday when i was growing up, watching my mom come home from the bank with the cash from her and my father’s paychecks.  She would always have a bank envelope of twenties.

The second she got home she would take the money and distribute it into a bunch of little sub-envelopes.

It wasn’t until years later that I learned the name for what my mother was doing.  I am not sure what the specifics are of her interpretation of the envelope method, but it must be pretty effective because she still does it to this day, and my parents (and their children’s) basic necessities were always met, even though my parents never earned high salaries.

At the time, I always thought the system was kind of ridiculous.  It reminded me of something a survivor of the Great Depression should be doing, not a baby boomer like my mom.

Technologically Advanced Version of the Envelope Method

So you can imagine my own surprise at the fact that I now use a more technologically advanced version of the envelope system as an adult.  Specifically, I use ING DIRECT sub-accounts in order to budget and save.

As I wrote about in this prior post on the subject of paying down student loans, my wife and I save specific specific percentages from each paycheck to be used towards specific saving goals such as our emergency fund, a car fund, a house fund, etc.

At most banks, you would be forced to go through an involved process to start a new account, even if you are already a customer.  However, at ING Direct you can create sub-accounts.  More importantly, you can give them a “nickname”.  In other words, you can name your sub-accounts “House Fund” or “Vacation Fund.”

The end result is the ability to create an online “envelope” savings or even budgeting system, and to view your progress easily all under one roof.   The interest rate’s at ING Direct are generally competitive as well.  I am sure most of my readers are aware of the ING subaccounts, but in case you are not they are something that have really helped me make sense of my savings goals and finances.

Budgeting with the Envelope System: Conclusion

If you can find the time to create a thorough envelope system, it can provide an effective means of budgeting and saving.  It is important to remember to:

1) Stick to the system: once you have used up an envelope, you must do your best to not spend any money on that category again until the envelope is refilled.

2) Avoid the “robbing Peter to pay Paul” trap of borrowing from funds.

3) Divide up big purchases into a per month or per paycheck amount so that you do not get blindsided with a big purchase that throws your whole system out of whack.

4) If your saving for something big, be particularly cognizant of perhaps consider moving the monies into a bank or another safe place in case there is a fire, theft, etc.

5) Be 100% committed to the system and know yourself and the psychology of YOU when creating it.  Make changes if necessary, but don’t use those “changes” as an excuse to go outside your budget.  Like most things in life and finances, the envelope system will only be as effective as you allow it to be.

Comments?

Do you use a version of the envelope system?  Have you found it effective?  Any additional advice not covered above?  Anyone reading really despise the envelope system?  If so, why?

I’m looking forward to some debate on this one, thanks for reading.

Note: My wife (Mrs. BrokeProfessional) has decided to come back to the brokeprofessionals fold and, as originally planned, help write articles on the site.

Tomorrow she is going to post on the subject of alternatives to cable, and she will explain the technology and techniques involved in ridding yourself of a steep cable bill (legally).

*(What is interesting is that many of the commenters say they would not use this method because they would “spend all the cash” when many studies apparently conclude that psychologically people tend to overspend more when solely using credit cards).  (See Moneycrashers.com explanation of this phenomenon, here).

**Image by: bulldogza.  bulldgoza’s portfolio is:

http://www.freedigitalphotos.net/images/view_photog.php?photogid=1663

updated: 2/2/11

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