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What is Envelope Budgeting?

Sticking to a budget can be difficult when you are unable to physically see yourself letting go of the money you have earned. When you use your credit or debit card to make a transaction, you do not experience the same pain of giving away something you’ve worked hard for, as you do when you pay in cash. This is because your money is tangible, you feel more accountable for it when you could give it away from your own hands.

This is why envelope budgeting is an efficient method for people who spend excessively by making transactions via a credit or debit card. In this form of establishing a budget, you are required to withdraw enough cash from your bank to pay off all your monthly living expenses and divide them by placing them in different envelopes. These envelopes determine the total amount of money that you can spend in a month, for a particular item. For instance, if you place £100 in an envelope dedicated to cost of fuel, you can only spend that amount on gas that month.

The strategy of envelope budgeting is a quaint, yet effective, method. If you struggle with creating a budget on spreadsheets or if you experience extreme difficulty in controlling the urge to shop online, envelope budgeting can be the solution to all your financial problems. You can go through the following guide to further expand your knowledge on the process of envelope budgeting.

Differences Between an Envelope Budget and a Traditional Budget

Traditionally, you create a budget by listing down sections or areas of spending on a spreadsheet. Next, you allocate a certain amount of money to each area that you normally spend on. In doing so, you are able to manage your finances accordingly. However, most traditional budgets are made by taking the historical budget data into account. It looks at the spending and earning patterns of the previous months, and make a few changes to ensure its application to the current month. The traditionally created budgets theorize and predict monthly financial planning.

On the other hand, the envelop budget method encourages you to implement the theory of a budget to practical spending. In this method, you do not have to rely on a spreadsheet. Instead, you can manage your cash simply by placing it in an envelope and separating them from other needs. For instance, you can dedicate an envelope to fuel, utilities, groceries and savings, etc.

In a traditional budget, you are not required to withdraw your funds from the bank. Rather, all you have to do is record your budget and make a mental note to abide by it. Additionally, when you are working with spreadsheets, you can calculate the amount of money you have left.

Conversely, an envelope budgeting system negates the need for a spreadsheet or automatic computations. This is because the cash is always in your hands, therefore, you have a first-hand idea of how much money you have left remaining.

In an envelope budgeting, you have the flexibility of changing or altering the budget as you move forward in the month. As the money is literally in your hands, you can add or remove a few pounds from a particular envelope, so you can adjust it in another. Hence, if an unforeseen situation arises, you can slightly alter your budget to deal with the problem effectively. However, in a traditional budget, one small change can impact the entire financial plan. If you attempt to make the traditional budget flexible, you may have to carry out your calculations all over again.

How does it work?

The envelope budgeting system can be extremely effective if you plan it right. In this form of budget, you are required to work solely with cash. Hence, you experience the consequences of your spending, exactly at that moment. This is because when you take out money from an envelope to make a payment, you can physically see the exchange of money. This psychologically influences you to make the necessary change in your spending patterns.

Additionally, this method further encourages you to reduce your reliance on a credit card. When you consistently pay with a credit card and have no means of returning the payment, you can find yourself in a huge amount of credit card debt. However, with the envelope budgeting technique, most of your payments will be made in cash, therefore, you would not have to use your credit card for most of your necessities in life.

Moreover, envelope budgeting can be effective if you make enveloped for the right categories. For instance, if paying the utility bills is more convenient through direct debt or standing order, you do not need to withdraw money for bills. If you create an envelope for a transaction that can be done online, you would have to spend extra money on fuel to travel all the way to the bank, in order to pay your utility bills in cash. Considering this, envelope budgeting is only effective if it is well-planned and thought out.

Envelope budgeting is a method that is designed to be fail-proof. It is exclusively engineered for you to avoid overspending. If you run out of cash in one envelope, you would have no means to spend more money. In theory, you shouldn’t extract money from another envelope, as that would create an imbalance in the overall budget. Considering this, the envelope budgeting method would certify that you only spend as much as you need to, and can afford to spend.

However, similar to implementing all other budgets, you would have to show a certain degree of restraint when you are using the envelope approach of creating a budget. You must prevent yourself from buying things you do not need.

Advantages of Envelope Budgeting

The envelope budgeting approach works by bringing your spending habits (quite literally) in front of you. This technique offers several advantages such as:

  • With envelope budgeting, you do not have to stick to a rigid schedule for payment. You can be flexible with the categories you make for yourself, as well as the amount of money you dedicate to each category/envelope
  • This method of budget creation is also ideal for you if your job doesn’t provide you with a steady income. Each month, you can vary budget for yourself, and allocate a different amount to each envelope. In addition to this, you can also eliminate the need for a particular envelope, if your income for a particular month is relatively lower.
  • The greatest perk of this method is that it enables you to stay on budget. When you run out of cash, you can simply avoid spending in that particular category. Although, this would only work if you remain honest with yourself, and implement the strategy with integrity (i.e. do not take out money from another envelope, unless it is an emergency!)
  • The method of envelope budgeting does not require the use of spreadsheet for calculation. Therefore, if you have trouble with technology, you can use this method to create your monthly budgets
  • The envelope budgeting method can function as restraint training. Once you integrate the discipline required to manage money by applying this strategy, you would be able to see the positive results. This could motivate you to implement a similar kind of discipline in other areas of your life
  • The strategy of envelope budgeting can also enable you to save money for your future. Whether you want to gather financial resources for an early retirement plan, emergency fund or an investment opportunity, you can use this method to set aside a certain amount for your savings
  • Another benefit of this approach is that you are able to avoid mindless expenses. Research shows that people spend 10% to 15% less when they use cash for their transactions. Hence, this approach would allow you to reflect thoroughly on every purchase

Disadvantages of Envelope Budgeting

 

Envelope budgeting is a beneficial strategy. However, the system is not entirely perfect. There are a few disadvantages to envelope budgeting:

  • In theory, envelope budgeting is ideal. Although, when you start the process, you would be required to carry out all your envelopes, every time you leave the house. If you do not have your envelopes, you wouldn’t be able to make payments. Essentially, the situation can be dangerous if you are travelling in an area with a high risk of robbery. In the unfortunate case that you do get robbed, you would lose all your money. To avoid this, you can extract a certain amount of money from your envelopes, prior to going out
  • Similarly, this approach could cause disorder in your life, when you first start it. If you have too many envelopes to manage, you may get lost in the process. However, with time and practice, you can master the art of envelope budgeting
  • Another downside of this process is that you would not be able to earn the benefits of using a credit or debit card. By paying in cash, you might miss out on the credit card discounts offered by your bank
  • If you are using the envelope budgeting technique, you would have to make at least one trip to the ATM. As all your transactions would be in cash, you cannot avoid this trip. For most people, this trip can be a burden in their busy lives
  • This approach of creating a budget can make it difficult for you to keep track of the money you have spent. As the cash keeps flowing out, you wouldn’t have a certain idea about the amount left inside the envelope. However, you can easily overcome this issue by noting down the total amount of money inside, on the envelope. This way, when you extract cash from it, you can subtract it from the original number, and note down the new remaining amount so that you are aware of how much money is present inside each envelope
  • Essentially, if you are shifting to cash as your primary method of payment, you would have to sell the idea to your partner as well. This is due to the fact that if they use the debit card from your joint account, you may risk going over budget. Selling the idea of using cash may not be easy. However, by educating your partner about the advantages of using this method, you can get them onboard too

How to create an Envelope Budget?

The creation of an envelope budget system is quite simple. The process does not force you to invest a lot of time in it. If you wish to create an envelope budget, you can follow the following steps.

Step 1: Make a withdrawal

The first initiative that you must take to create an envelope budget is taking out the money from your account. Visit a nearby ATM and withdraw at least 80% of your income left over after paying mortgage/rent and utility bills that are usually paid via direct debt or standing order. Leave some amount for your other direct debts (like mobile bills) that cannot be paid in cash. If you are opting for this method for the first time, you can leave some extra money, in case you go through your envelopes rapidly. However, you must only use that amount in the case of an actual emergency. Otherwise, the budgeting would not be effective.

Step 2: Plan the envelope categories

The envelope categories define the areas in which you spend your money. An advantage of this strategy is that you have full control over deciding the categories. Commonly, you can choose to create the following envelopes:

  • Groceries
  • Fuel/ Transport
  • Entertainment
  • Emergency fund
  • Eating out money

Step 3: Allocate money

Once you have decided the number of categories and titled the envelopes in accordance with the category names, you can move to the next stage of allocating a portion of your budget to each envelope. This portioning is entirely dependent on your total income and your financial situation. If you have an existing budget, you can base your amount in the envelopes in accordance with the previous budget. For instance, if you pay spend £200 a month on grocery then have £200 in notes in the envelope titled “grocery”.

Step 4: Spend carefully

As soon as your envelopes are created, you can start spending your money. However, be sure to keep a regular check on the amount of money you have left remaining in each envelope. This will ensure that you remain careful with your spending.

Example of an Envelope Budgeting

An envelope budget strategy is based on the budget you set for the category, and the frequency of when you add your money to the envelope. Once you have created the categories, and have decided the amount for each envelope you can get started. If you are paid once a month, you can set the budget right after getting paid. However, if you get paid twice a month, you can add money gradually. For example, if your monthly budget for food is £200, and you are paid every two weeks, you can add £100 to the “grocery” twice a month. Similarly, if you receive a weekly pay check, you can add £50 to the envelope, once a week.

Is it the right type of budget for you?

The approach of envelope budgeting has its pros and cons. The method of creating a budget is perfect for you if you are an over spender who lacks discipline. The envelope budgeting technique entirely eliminates the idea of spending extra money. Hence, switching to this budgeting option can bring out a positive change in your financial matters.

On the other hand, if you reside in a neighbourhood where operating with cash can be a risk, this option may not be ideal for you. However, you can find alternate solutions for this issue, such as, by carrying your cash in secured pockets placed within your garment (such as your socks, shoes or money belt). Additionally, you can avoid using public ATMs, and choose to withdraw your cash from a secure location.

The envelope strategy would also be perfect for you if you are not comfortable with digitising your budget. As this technique relies on the use of the traditional methods comprising of paper envelopes, pen and cash, you can save yourself from the trouble of creating a spreadsheet.

In addition to this, the envelope budgeting approach could work out in your favour if you are a compulsive online shopper. You can apply this strategy to accommodate your situation by withdrawing all your money from the bank. If you do not have any money in your account, you wouldn’t give in on your temptation and make a purchase online.

The envelope budgeting strategy could also be applied if you have a variable monthly income. This format of budgeting would make it easier for you to create a different budget each month, based on the month’s aggregated income.

Additionally, this method would further add discipline and control, to the way you spend your money in your day to day functioning. By using a tangible entity, such as cash, you would ruminate over your decision before making a purchase. This would enable you to spend wisely.

Conclusion

With an envelope budgeting, you are required to distribute your income in physical envelopes, dedicated to different areas of spending. By solely operating through cash, you can avoid overspending and apply the theory of a budget to your day to day spending. While there is a certain degree of risk involved in carrying cash, while moving forward with your monetary transactions, you can eliminate all the potentially dangerous situations to ensure the effectiveness of this strategy. Envelope budgeting can be the ideal form of creating a budget if your plan is detail-oriented.

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