After almost 30 years of managing my finances, or the lack thereof, my absolute favorite way to handle my money is the envelope system. The reason is simple: it works! I can make sure I have enough money to pay my bills, save for the future, and maintain my recordkeeping system. If you need to make some adjustments to your financial system, or don’t have one yet, I highly recommend you take some time today to set up an envelope system. Here are 6 simple steps to get you on your way. I have a worksheet that will help you work through the steps.
Step 1: Choose categories and percentages
In order to set up your envelope system, you will need to decide which categories, or envelopes, you need. This will vary slightly for each household, but many expenses are the same. Here are my categories to get you started.
- Bills (mortgage, power, phone, internet, garbage pick up)
- Daily (groceries, gas, toiletries, cleaning supplies, the stuff you buy at places like Walmart)
- Medical (regular appointments like chiropractor, dentist, and a surplus for copays, etc.)
- Farm, pets (feed, vet, etc.)
- Car repair (everything except gas)
- School (curriculum, membership fees, educational activities)
- Insurance (Car, registration, life)
- Home and heating (Home repair and improvement projects, firewood, propane)
- New car
- Emergency fund (minimum of $1000, aiming for 3-6 months income, used for only emergencies)
- Trips (saving for some field trips with the family)
Use my printable worksheet to help you list all your known expenses. My list of categories should help jog your memory. Don’t forget subscriptions and annual payments. List your income as well. Compare the two to determine the percentage of your income that should be put into each category. For example, if your bills total to $1000 a month, and you get paid $4000 a month, you will set 25% of your income into the bills category.
Step 2: Decide on your record keeping system
You will need to decide if you will use cash in actual envelopes, or use other forms of payment, like credit cards, and keep track of the amount in each envelope either on paper or digitally. Cash in envelopes is easy to track. When the envelope is empty, you will have to stop spending. A possible downside to cash is the inability to pay some bills and order online. For this reason, I choose to use a credit card and a budgeting app on my phone. Whatever you decide, get it ready. You may need to assemble envelopes, or download software or an app.
Step 3: Get an accurate money count
Go to your bank account and get totals in your accounts. Check your credit card balance and subtract it from your total. Count your cash. Perhaps you have a paypal account that needs to be added. Whatever money you have that you want available for your budget needs to be counted. Be careful to subtract outstanding checks as well.
Step 4: Divide your money into categories
Now that you have a total of your current money, use the percentages you established in step 1, and divide your money into categories. If your money is not all in cash, you could consider using a mixed system. For example, keep your daily category in cash in your wallet, while the rest of the categories are in your bank account and tracked on either paper or digitally.
Step 5: Develop a system for recording income/expenses
The envelope system only works if you work it. You need to be consistent. The most ideal method is to subtract expenses as soon as you have a receipt. I try to subtract all receipts from a trip to town as soon as I get home. I also deduct bills from the appropriate category as I pay them. Getting paychecks is the most fun! I get to replenish all the categories with more money! If you are choosing to use a credit card, as I do, record keeping is essential. Please read my post on how credit cards work, so that you are using them responsibly. I double check my credit card every 1-2 weeks. I copy down every charge on paper and check that each charge was subtracted from my categories. If I missed something, I enter it in. Once every entry is crossed off, I pay the bill in full. This means the full, current amount, not the statement balance. This way, my credit card never gets the better of me.
Develop a routine that works for you, so that each expense is subtracted promptly, and you know exactly how much you have in each account.
Step 6: Start tracking
Now that you have your envelope system set up, start tracking! Remember that with an envelope system, you can build each category up over time. If you are careful with your grocery spending this month, your balance will go up. You can save for annual expenses like insurance this way, since you are putting a certain amount in each month, and not spending it.
If you have any questions while setting up your system, please drop them in the comments below, and don’t forget to pick up your free worksheet to help you through the steps.