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The cash envelopes method is a cash-based budgeting strategy. The general premise is that if you set concrete spending limits for each of your expense categories and only use cash, you’ll be less likely to overspend. However, the cash envelopes method has mixed reviews and isn’t right for everyone. Here’s everything you need to know.
Where did the cash envelopes method originate?
The cash envelopes method was first popularized by Dave Ramsey, a giant in the personal finance realm known for helping people get out of debt. While you may not be interested in the history of this budgeting strategy, it’s important to understand the intentions behind its creator. Ramsey is well known for his conservative approach to spending, saving, and debt management. More often than not, his advice is that many of us can’t responsibly take out a loan or use credit, and therefore it’s better to avoid them altogether.
The problem with that assumption is that debt, loans, and credit cards are not inherently bad. They are tools. They can be used to our benefit just as much as they can be used to our detriment. Some tools are better than others, but it is the decision to use them or not use them which can be harmful.
Here at The Ambitious Dollar, we believe a better strategy is to educate consumers on the best ways to use the tools available to them, rather than attempt to eliminate any option that involves even the slightest degree of risk.
With that being said, a cash-based approach is not a bad way to budget. It simply comes with its own set of drawbacks, as does every other method. So without further ado, let’s dive into how the cash envelopes method works, and the pros and cons associated with it.
How does the cash envelopes method work?
1. Create your budget
If you already have a budget, skip to step 2. If you don’t, follow these steps to set one up:
a. List your expenses
Take a deep dive into your monthly bank and credit card statements to figure out exactly how much you spend each month. If this is your first time budgeting, or first time creating a budget in a while, repeat this process for at least the last 3 months to account for any seasonal variability and fluctuation which naturally occurs throughout the year.
b. Calculate your take home
Be sure to include all your sources of after-tax income so you have a clear idea of how much money you have to work with.
c. Set your goals
It’s incredibly important that while you’re focused on determining your expenses that you don’t forget to pay yourself first. Be sure to factor in your goals for savings, an emergency fund, and retirement. If you don’t, it will be all too easy to spend every penny you have without any money leftover to help you prepare for the future.
d. Create your categories
After subtracting your monthly savings goals and expenses from your take-home pay, you can begin creating categories. Common categories include things like utilities, groceries, fun money, etc. You can be as specific or as general as you’d like – do whatever seems most intuitive and helpful. However, if you choose more general categories, make sure you have a clear understanding of exactly what falls into each, otherwise you may be inclined to start bending your own budgeting limits.
2. Set category monthly spending limits
Start setting monthly category spending limits for your necessities first. These include things like food, utilities, rent, etc. Be sure to consider which of these expenses are variable and which are fixed. Things like your rent or mortgage payment will likely remain the same each month. However, expenses like car maintenance or your electricity bill may fluctuate month to month. A good tip is to average out those expenses.
For example, your electricity bill might be $200 in July, but only $50 in January. Instead of listing a different category limit for each month, you could calculate the average monthly electricity bill over the course of the year and set that as your spending limit. Perhaps your average bill calculates out to $125. In months that your bill is less than $125, that surplus of cash will roll over to the next month. And in months that your bill is higher than $125, the surplus will cover the difference.
After you’ve taken care of your essential categories, you can begin setting budget limits for any remaining categories ensuring that your total category spending limit does not exceed your take home pay. You may end up with something like the following:
3. Create envelopes for each category
Here is where the cash comes into play. Now that you have your categories set, each with their corresponding monthly spending limit, you can create your envelopes. While this method was initially developed with literal, white letter envelopes, you now have a bunch of different options including wallets and binders which can help keep your money organized and safe.
Whatever method you choose, you’ll want to label your envelopes with at least the category title and monthly spending limit to keep yourself accountable.
4. Depositing and spending the cash
Now on to the cash logistics part of this budgeting method. Since you’ll be using cash to pay for your expenses (as much as possible), you’ll need to prepare your envelopes before the start of each month so you have the required money on hand.
Cash envelope users commonly pull cash out of their account either once or twice a month, depending on individual preference and to accommodate how often they get paid. You can choose to take out cash at the end of each month or on each payday. Just be sure to keep in mind any specific monthly bill due dates. You may want to consider adjusting them to align with your cash withdrawals.
For example, say your electricity bill is usually due on the 10th of each month. However, you want to take cash out according to your payday schedule which is every two weeks. Moving your electricity bill due date to the 28th of each month will make sure you have two paydays worth of cash and enough on hand to pay your bills.
The rest is simple. You’ve set your spending limits, allocated cash according to your budget, and now you can pay your expenses with cash from their corresponding envelopes.
Analyzing the cash envelope method
Now that you know how the cash envelopes budgeting method originated and how it works, let’s get into the pros and cons of this strategy.
Perhaps the greatest benefit to using a cash-based budgeting method is the fact that your transactions are physically felt as you handle the cash. There’s much less of a tactile connection when spending money by swiping your credit card which can make overspending a little too easy. This mind-body-cash connection can be particularly helpful for those who struggle with their spending habits. It limits the possibility of overspending and allows you to focus on creating a positive, healthy relationship with money.
While any budget is ‘on your honor’ – there are no budget police. Using cash helps you keep yourself more accountable. If you follow the rules and only spend cash, it’s nearly impossible to go over budget because once you’ve run out of cash, you’ve got nothing left to spend. This budgeting method is also one of the simplest options out there. Cash in, cash out. As long as you’ve set your categories, spending limits, and goals appropriately, there isn’t much to it.
Let’s be realistic, not everything is easily paid for with cash. Some companies aren’t set up to allow cash payments at all. For companies that do accept cash, you may have to inconvenience yourself by driving across town each time a bill is due so you can pay in person. What are the chances you might accidentally miss one of those deadlines because you forgot or simply couldn’t get there by close of business?
The need for a credit or debit card
All this goes to say that you will likely still need to rely on some form of credit card or debit card. That doesn’t need to be a deal breaker, but it’s worth considering as you evaluate what budgeting method works best for you.
As we already mentioned, credit cards are not inherently bad. Can they be used poorly? Absolutely. However, if used properly, they can provide users with a number of benefits like purchase protection, rewards dollars, product warranty extensions, etc.
Once cash is gone, it’s gone
It also goes without saying that you’ll need to be very careful about how and where you keep your cash. Because once cash is gone, it’s gone. Whether someone steals it, you have a house fire, or you simply misplace it, there’s no getting it back. While credit cards can be stolen, most offer protection against fraudulent charges.
Cash envelope budgeters will also need to fight the temptation to move cash around between different envelopes. Is moving leftover cash from your utility envelope to your grocery envelope against the rules? No, not necessarily. But, the rationality of allowing yourself to spend more in one category because you spent less in another is just overspending cloaked in a veil. The responsible thing to do would be to roll over your additional utility funds for a future month which may exceed your predicted costs…rather than buy a big fancy steak that wasn’t in the grocery budget.
Finally, while checking accounts don’t historically pay much in interest, they pay more than 0% – which is what you get when you keep your funds in cash. You’re working hard to make your money – you should make your money work for you too. Even small percentages can add up, especially to help offset inflation.
The bottom line
The cash envelopes method is far from perfect. However, no budget is perfect. If you find one – you’d better hit us up in the comments below and share the love.
Here at the Ambitious Dollar we are firm believers in doing what works for you. If that means you create some sort of hybrid cash envelope system to keep your fun-money spending in check – do it. Or perhaps you’ll just decide to use cash in situations where you know you’ll be tempted to overspend – casinos, auctions, bars, etc. The most important thing is to find a system that works for you, otherwise you won’t stick with it and then what’s the point. Don’t be afraid to try something new, but certainly don’t be afraid to veer away from whatever isn’t working.
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