How to budget using the envelope method

Here’s five simple steps to create a budget that doesn’t involve tracking every expense. 

To achieve our financial goals, we need to know where our money is going. This is why having a budget is so important.

What’s even more important is to find a budget that works for you.

The envelope method is ideal for people who don’t want to track every single expense in their budget and want to increase how much money they are saving. Some people call this the cash stuffing method. This method gives you a great idea of where your money is going.

Here’s how it works:

Step one is to divide your expenses into different categories, such as for groceries, energy costs, housing, clothing, entertainment, transportation, and also debt payments.

Step two is to get an envelope for each category. You can use paper ones for physical cash, or virtual envelopes (for example, a computer file). This comes down to whatever works best for you.

Then label each envelope with the categories for each of your expenses. If you think of more as you go, create a new envelope.

Step three is to figure out how much you plan to spend on each expense category throughout the month. Then, for each category, put that amount of cash into the relevant envelope or record the amount in your virtual envelopes file.

If, in the middle of a month you realise you need to spend more in a certain category, you’ll need to dip into other envelopes to make up the difference.

But try to not make this a habit, because it’s best to remain aligned to the spending goal that you have set for each envelope.

Step four is to look at each of your envelopes at the end of each month to see how you went against your actual expenses.

Did you stick to the amounts in each envelope, or did you have to shuffle money around? Did you have any money left over?

The idea here is to use this information to adjust the amounts for the following month if required. You may realise that you need to move money from one category to another.

This means that you have to cut some expenses from other envelopes. And that’s fine, because you’re learning where your money goes.

Step five, and most importantly, is to keep it up. The longer you stick to a budget the better you’ll get at budgeting, and you’ll improve your chances of reaching your money goals.

The psychology behind the envelope method

So, why does the envelope method work for people’s budgeting psychology?

Two reasons come to mind. First, when we use cash in our daily transactions, we become more mindful about how much we’re spending compared to when we’re just tapping or swiping a credit card. So, by using money, you become less inclined to overspend.

The second reason is related to the theory of mental accounting. By dividing money into categories it reminds us of our budget limit within each envelope.

It also discourages us from tapping into money from other categories because there is a physical separation among the envelopes, so we are less likely to overspend and more likely to stay within our budget.

To create a budget that works for you, reach out to the team at ADR Wealth.

Source: Vanguard