What is the Envelope System?
You’ve probably heard the term “envelope system” or “envelope method” when it comes to budgeting your money. What exactly is it and how does it work?
The first time I remember hearing about the envelope system was when I was a missionary in South Africa. As missionaries, we or our families paid our own way. We each gave the same amount each month that went into the missionary program as a whole and then it was divided up as need to various missions throughout the world.
We were given a certain allotment that was deposited into our bank accounts each month. We would then go to the ATM and withdraw cash as needed.
This was around 1996-1998 in South Africa. We only had ATM cards – no checks or debit cards.
In our mission, we had a mission president who led about 150 missionaries in various cities around Cape Town. We often had meeting where the president and his wife would speak to us.
At one point, a lot of missionaries were complaining that they didn’t have enough money to make it through the month. Yet, other missionaries seemed to do OK sticking to their monthly allotment.
The mission president’s wife took this as an opportunity to teach us some budgeting principles. She told the story that went something like this…
When President and I were young and newly married, we did not have much money to live on. I learned about a way to manage our money that worked well and has stuck with me ever since.
As soon as we got paid, I would withdraw all our money except for savings and then divide it up into envelopes. I had envelopes for food and groceries, house payment, utilities, clothes, etc.
Before I would spend I would look in my envelope for that category and see how much I had available. I knew it had to last for the whole month.
I remember thinking something along the lines of, “that is sound advice, but not really relevant to our situation.”
The mission office took care of our rental payments. We were basically given the money we needed for food. As missionaries we didn’t really have other expenses to worry about. We brought two years worth of clothing and any other supplies we might need.
Some missionaries that worked in larger areas had cars, they were given a little extra allotment for petrol (gasoline).
So really, if I were to use the envelope method at that time, I would have two envelopes (food and petrol). I guess I could have split foot into groceries and eating out, but I pretty much knew I could only eat out about once a week in order to stay within budget.
So this is the essence of the envelope system.
- Get paid
- Decided how you are going to spend or save every dollar of that paycheck and allocate each dollar to an envelope or category.
- Follow your plan
What happens if you run out of money in a certain envelope? You have two options.
- You stop spending money in that category and wait until next month
- You make a decisions to change your plan and pull money from another envelope.
Let’s look closer at the second option. Let’s say your car breaks down and you need to spend $300 to repair it. You need to look at your other envelopes to come up with that money. That may mean pulling from an emergency fund envelope or, if you must, your vacation envelope.
This all sounds nice in theory, but who wants to go to the bank every paycheck and withdraw cash?
As soon as I got home from my mission I got a job and set up a checking account. That was when I also got my first debit card. I first started using it at gas stations. It was great! I could swipe, pump and drive away without having to go in and pay the attendant.
I found that most places took my debit card. I visited banks and ATMs less and less.
Then my bank started offering online banking, where I could get on the internet and see my balance. Again, I had even less reason to visit the bank.
Today, I rarely visit the bank. The last time I went to the bank was to sign a paper after opening a business account. I do everything online and with debit cards.
But, the problem with this is that it can be very easy to spend your money, but a little harder to track your money.
Your bank account balance is one number. How do you know what number that balance represents? Yeah, you could open 7 bank accounts and that would give you a better picture of your balances. But, now you have 6 more balances and logins to manage and is it really giving you a better picture of what you have to spend in various categories?
I do have multiple accounts. They are:
- Family checking account
- American Express cards
- Medical Flex Spending Account (Similar for HSA, but I’m on a low deductible plan so I don’t qualify for HSA)
- High Yield Savings account
The American Express cards are simply for rewards for my normal spending habits. Last year we paid for Christmas with our rewards.
The medical flex spending account is a benefit offered through work where I can pay for medical expenses tax free.
The high yield savings account is an account where I keep my emergency fund. It is online and takes 2-3 days to transfer money. It keeps my emergency fund just a bit less accessible, which I prefer, and allows it to earn a little more interest than if it were just sitting in my checking account.
Everything else happens in grand central station – our checking account.
In order to make sense of our checking account balance, I have implemented a virtual envelope system. With Envelope Budget I follow the same pattern as the classic envelope system:
- Get paid
- Decided how we are going to spend or save every dollar of that paycheck and allocate each dollar to an envelope or category.
- Follow our plan
My paycheck is direct deposited into our checking account every two weeks. I then allocate that paycheck to my various envelope categories. As I spend, I look at my envelope balances before I spend to make sure I stay within our plan. Transaction are imported into Envelope Budget as I spend. I associate them with envelopes with automatically updates each envelope balance so I can stay within budget.
Of course I have lots of tools and shortcuts built into my system to save me time. For example, I have allocation plans that help me allocate my paycheck each month. I also have a mobile app that lets me see the envelope balances I need to on the go.
Of course, this is all virtual, my bank is pretty much unaware of my envelope system as it doesn’t need to be.
My bank account balance is simply a number. It represents a pile of cash. Envelope Budget gives order to that number. I essentially lets me take that pile of cash and organize it in a meaningful way so that I can buy groceries in peace know that I am not spending our mortgage payment.