Cash Budget and The Envelope Method

Easy Ways to Save Money – Cash Budget and The Envelope Method

Today, we are talking about the cash budget / envelope method strategy as an easy way to save money.

However, first, we need to address: credit cards. We love them. First, we love the ease of quickly swiping your card at checkout and moving on with your day. We also love the rewards we get with them and the simplicity of having one consolidated bill to pay.

In addition, we love the quick checkout of online shopping when our credit card number is on file and we just have one button to click and voila – a package arrives at our doorstep. And, at least subconsciously, we love not having the stress of whether or not there is money in our checking account today to pay for the purchase…that can get sorted out next month.

The Price of Paying with Ease

But that ease comes with a price. A pretty steep one in fact, according to Forbes. Research shows that consumers are willing to pay up to DOUBLE the price if paying with a credit card than with cash. That’s a lot of extra spending that dwarfs even the best rewards program! Additionally, for the majority of Americans who don’t pay off their credit cards each month, interest rates can be 20% or more. Between excess purchases and interest fees, that adds up very quickly!

The Benefits of Paying with Cash

Paying with cash, on the other hand, drastically reduces how much you spend, making it easier to save.
When you pay with cash, you actually see how much you are paying and feel the pain of handing over a large sum of money. However, with credit cards, you can walk out of the store on a spending high with little thought to the consequences.
In addition, with a cash budget, you live with the immediate reality of the money you are handing over, making you less likely to spend more than you really want to. And then there is the obvious – with cash, once you are out you are out.

A Cash Budget Case Study

set up a cash budget in three easy steps

To illustrate our point, let’s do some simple math. Say a person intends to spend around $1,500 a month on groceries, eating out, household items, clothing, and miscellaneous items. With cash spending, you can limit yourself to that $1,500. But with credit cards, you could easily spend an additional $180 each month or more.

Even with some of the best rewards programs, you will only get back around $35. In a year, the person using the cash budget will have spent over $1,700 less than the credit card spender. In addition, that person using the cash budget is no longer paying interest fees for credit cards. As a result, they will have saved $200-300 a month – adding up to around $2,000 for the year. The cash budget will have saved this person thousands!

3 Easy Steps to Start a Cash Budget

Considering a change but not sure how to start? Let’s talk about The Envelope Method – a system that uses envelopes to allocate the cash for exactly how much money you want to spend. When you leave home, you grab the money from the envelope and do not allow yourself to spend more than what you have cash for.

So let’s get started.

Step One: Create and record a budget

I like to keep my monthly budget in a spreadsheet (like from Excel), but you can keep it anywhere you like – a piece of paper, a sophisticated financial software program, or anything in between.

How to Determine Your Budget

Every month you will have fixed expenses (like your mortgage or rent payment) and variable expenses (like groceries).

Start by taking your net income each month and subtracting out the fixed expenses that you know you will have – like your mortgage or rent, car payment, insurance payment, cell phone bill, utilities, etc.

Then, you need to determine how much you want to spend on variable expenses.
- List out each category of spending – groceries, supplies, dining out, entertainment, gas, clothing, donations, etc.
- Take a look at the last several months of your bank or credit card statements to see how much money you are actually spending in each of these areas. This is not necessarily a pleasant task, but if you don’t know where you are overspending, you can’t correct it.
- Determine how much you actually want or need to spend in each area and deduct that from your income.

Consider a Slush Fund

Unless your budget is extremely tight, you may also want to consider a small slush fund category. This money can be used for fun or spontaneous purchases, or saved for a larger fun or spontaneous purchase later.

If you are not naturally a very disciplined person, The Envelope Method could seem a bit constricting. Having a little, even if it’s just $20 a month, in a slush fund to spend on whatever you desire can help ease the pain of the transition.

Determine Your Savings or Deficit

The amount remaining is how much you have to save each month. Hopefully you have a pleasant surprise at this point, realizing that yes, you really can save that much! However, you might also have a not so pleasant surprise – like discovering that your eating out and entertainment expenses are putting you in the negative each month. That’s a tough realization, but it empowers you to make different choices to meet your savings goals.

If you are in a deficit, check out our tips on frugal living and saving money here.

An Example of a Monthly Cash Budget

Below is an example of a very simple budget, for illustration purposes. This example is a monthly budget, but you could also consider doing a weekly or biweekly budget depending on how often you are paid.

Step Two – Prepare the Envelopes

First, determine a safe place to keep your envelopes of cash. This could be a drawer or a filing cabinet or someplace else.
Next, list out the spending category for each of your variable expense types – groceries, clothing, gas, eating out, etc., each on an individual envelope.
Then, determine how you best want to organize them so that you can quickly find the envelope you need.

Next, Prepare the Cash for the Envelopes

After each paycheck, assuming it is electronically deposited, withdraw the amount of money you have budgeted for cash spending. Be sure to ask the teller for bills that are small enough you can divide the money up correctly.
Then pull out your budget and put the correct amount of money into each envelope. In the example above, you would need to withdraw $675 from the bank and divide it up correctly over the 5 envelopes.

Extra Cash for Unexpected Needs

Depending on how often you need to spend money, you may wish to keep some extra cash in your wallet. For example, take an extra $50 out the first month only to put in your wallet. Then if you happen to be out and need to spend money unexpectedly, you can simply pay for the purchase with the money in your wallet and immediately reimburse yourself from the correct envelope when you get home.

It’s important to immediately reimburse yourself so that you aren’t overspending and needing to pull out that extra $50 each month.

Step Three – Use the Envelopes

Perhaps the most challenging part of this process is remembering to get the cash out of the envelope before leaving the house. That’s why keeping a cushion in your wallet is helpful. Additionally, you could keep your checkbook and/or debit card with you at all times. However, you should always have a backup plan to avoid using your credit card!

Tips for Success

pin for easy ways to save money by using the cash budget and envelope system

Before leaving the house, grab the cash that you intend to spend. Going back to the example budget, if you budget $400/month for groceries and go shopping once a week, you may always pull out $100 before heading to the store.

Or perhaps you shop for different items at different stores and you know one week is more expensive than the next based on what you are buying – adjust accordingly. Maybe you need $80 this week and $120 the next. It’s fine to vary how much you pull out of the envelope each time, but make sure that you stick within the cash you have for the month.

Of course, real life is difficult to balance down to the penny. There may be times when you have to spend more in one category than you were expecting. For example, perhaps you are hosting Thanksgiving and you are going to blow past your set amount for groceries. When that happens, you can turn to your slush fund (if you have one) or reallocate money from a different envelope – perhaps you choose to not eat out this month and pull it from the entertainment envelope.

What to Do with Extra Money

On the flip side, you may find that at the end of the month you have some money left in an envelope. You could put it into your savings account, keep it in the envelope for next month, or reallocate the money to a different expense. In all of these situations, the great news is that YOU are in control of your spending and you are staying within your budget.

Imagine going to the store with $50 in cash from your clothing envelope to buy a new pair of shoes. At the store you find the dress shoes you need to replace the ones you have that are worn out – great! But then you notice another pair that you like that are on sale.

In the past, it would have been easy to just put both pair on your credit card and not given it a second thought…until the bill came. But now you are on the cash only method.

You have two choices:

You can either forgo the second pair knowing that, while the shoes are nice, you have worked hard to get on this savings plan and you don’t want to feel the physical pain of having to hand over the extra cash and cut spending elsewhere.
Or you can decide you really like that second pair and pull the money from your slush fund envelope for this month. Guilt free spending.

The Cash Budget / Envelope Method Applied to Savings

You probably have a checking account to handle short term expenses, as well as long-term savings accounts like a 401(k). But if you don’t already have one, I recommend that you have a savings account for medium-term expenses – like vacations, gift giving, house expenses, etc.

When you are in a position to save money each month instead of living paycheck to paycheck, you will need to save for larger expenses that the envelope funds won’t cover. Perhaps you are planning a vacation or your house needs a new furnace. If you are proactively saving, you can avoid putting these items on credit cards.

How to Keep Track of Goals

Having a savings account for each thing you want to save money for could be a bit cumbersome. But it’s very easy to keep an Excel file, or use a notebook, and list out exactly what the money in the account is for.

For example, you want to go on a trip next summer and your dishwasher is on its last leg so you know you will need to replace it soon. You are sticking with your cash budget and able to save $400/month. Each month you intend for $200 to go toward your vacation, $100 to go toward your dishwasher, and $100 to go toward building your emergency fund. Your savings account tracker would look something like this:

Each month you add to whatever category you are saving for. If you need to take money out of that category, then update your tracker accordingly. Money can sit in there as long as you like – in this example the “Gift Fund” wasn’t accumulating any more money but $250 was available at any time to purchase gifts.

Cash Budget Conclusions

Credit cards make it easy to overspend without even realizing it. If you don’t know where you are spending your money, you are likely overspending.

The good news is that with some simple organization and discipline, you can make sure you are spending your money intentionally. Cash budgeting using the “envelope method” is a great way to keep yourself from overspending and make it much easier to save money.