How to Use Cash Envelopes as a Budgeting System
If you’ve been reading my blog for a while, you know that I’m a huge fan of budgeting. I don’t call myself a budget & financial fanatic by night for nothing. So, I thought I’d shed some light on a budgeting technique that has helped tons of people: the cash envelope system.
What Are Cash Envelopes?
Cash envelopes are pretty much what they sound like: envelopes that you put cash in. The tricky part is that you are only allowed to spend what you have allotted in each envelope. I know, that’s easier said than done!
What is the Cash Envelope System?
The cash envelope system isn’t actually a new budgeting concept. In fact, people have been using it as a way of budgeting since the 1880s. However, finance guru and radio talk show host Dave Ramsey made it famous back in 1998 in his book The Financial Peace Planner: A Step-by-Step Guide to Restoring Your Family's Financial Health. Just for your reference, I do want to note that he leaves out the “cash” and just refers to it as the “envelope system.” I’m going to refer to it both ways.
The way the cash envelope system works is pretty simple. Basically, you set a monthly budget, create an envelope for each budget category, and fill it with cash. (I’ll talk more about budgeting categories in a bit.) Then, you are only allowed to spend the cash you have in each envelope.
According to Dave Ramsey’s website, using this system should help you “retrain your brain on how to handle money.”
Ramsey believes that when people use credit and debit cards to buy things, they tend to spend more than they would if they were paying with cash. So, using cash is a way to get people to spend less and actually stick to their monthly budget. Supposedly “paying with cash actually feels different” than paying with your credit or debit card. Apparently, paying for things with cash activates pain sensors in your brain that are triggered when you feel the money leaving your hands.
Pretty interesting, huh?
Who the Envelope System is Designed for
Dave Ramsey’s envelope system is great for anyone who is looking to:
- Stick to a monthly budget
- Pay off debt
- Build up savings
- Start an emergency fund
- Learn how to stop spending money that they don't have
Do Cash Envelopes Work?
If you follow the system, then yes they do. Debt.org gathered some great info from several different studies pertained to paying for things with cash versus credit or debit cards. Here are some of the key findings they pointed out:
- Avni Shah, a professor at the University of Toronto Scarborough and Rotman School of Management, found that paying with cash triggers different pain sensors in the brain. (This must be where Dave Ramsey got this from.) Shah also concluded that using cash encourages people to shop around for better prices, while breaking out the debit or credit card often makes people spend more on things.
- In 2016, Shah and researchers from Duke University and the University of North Carolina conducted a study that concluded that credit/debit cards make consumers feel less connected to purchases, so they end up spending more.
- In 2001, two Massachusetts Institute of Technology professors conducted a study where they randomly selected participants and offered them the chance to purchase tickets to an important sold out basketball game. Some of the participants were told to pay with cash, and some were told to pay with their credit cards. The findings showed that those who were told to pay with cash, were less willing to part with their money than those who had their credit cards on hand. In fact, the credit card users ended up spending twice as much as the cash spenders.
So, yes, the cash envelope system works, it just takes a lot of effort and self-control.
Advantages to Using Cash Envelopes
Like any budgeting technique, there are lots of advantages to using cash envelopes, including:
- Using cash makes it harder to overspend.
- If you do it right, using cash envelopes can help you get out of debt.
- Sticking to cash stops you from racking up credit card debt.
- Using this system can help break your online shopping habit.
Getting Started with the Envelope System
On his website, Dave Ramsey lists four steps to getting started with the envelope system. I’ve broken these steps down a little bit more for you, so I have seven.
Step 1: Think of the different budget categories you will need cash envelopes for.
Just like some of the budgeting software platforms I’ve written about, like Mint, the cash envelope system also requires you to set up different budgeting categories.
Here are some popular cash envelope budget categories I saw while researching this system:
- Restaurants/Take Out
- Toiletries (Hair Care/Makeup/Skin Care/Grooming, etc.)
- Car Maintenance/Repairs
- Entertainment (Movies, Theatre, Concerts, etc.)
- Gifts (Birthday, Christmas, Valentine’s Day, etc.)
- Self Care (Massages, Facials, Manicures, Pedicures, Gym Membership Fees, Meditation App Subscriptions, etc.)
- Fun Money
- Emergency Money
- Miscellaneous Expenses
To learn more about budgeting categories, including the ones I think are most important when setting up a monthly budget, check out my post: The Top Budget Categories You Actually Need.
One thing to keep in mind is that you don’t have to create a cash envelope for everything you buy. Plus, there are just some things that you are going to have to pay for online, like your utility bills or your Netflix subscription. So, focus on the categories where you need to curb your overspending, like ordering take out.
Step 2. Determine your monthly budget for each category.
Now, here’s the hard part. You have to figure out how much you want to spend for each of your budgeting categories and stick to that amount. So, if you are going to budget $800 a month for groceries, then that’s what you are allotted for the month. No more!
I wouldn't use back of the envelope calculations for this (see what I did there? 😉 ). If you need a budget that works well with cash envelopes, I suggest this one.
Step 3: Enlist the help of an accountability partner.
Dave Ramsey actually suggests this on his website. It can be really hard to stick to a budget, so having an accountability partner who will actually hold you to your budget can really help keep you in check. This can be your partner, a friend, a family member, etc. Just pick someone who won’t let you slide or fall off the “budgeting wagon” per say.
Step 4: Fill each envelope with cash.
Okay, so you’ve created envelopes for each of your desired categories and determined how much you want to spend on those categories each month. The next step is to head on over to your bank and get the cash you need and fill up those envelopes. So, if you budgeted $100 a month for take out, fill that envelope with, you guessed it, $100.
Step 5: Use the cash in each specific envelope when you make a purchase for that category.
So, if you make a Target run to get some lotion, take your toiletries envelope with you.
Step 6: Put any change back into that envelope and calculate the balance.
Once you get home from your shopping trip, this is also a good time to take note of what you have left in that envelope and write it down. This will help you plan for future shopping trips for that budget category.
Step 7: Do not spend more than you have in each envelope!
Here’s the even harder part. You cannot spend more money than you have. So, if you’re at the grocery store, and you only have $100 left in your grocery envelope, and your total is $120, you have to put some items back. It’s not fun, but at least you won’t go over grocery budget and it forces you to take a closer look at your spending. (If you specifically need help with a grocery budget makeover, read more here!)
Like I said earlier, sometimes you just have to buy things online. If you need to make an online purchase with your credit card, take the money you spend out of the designated envelope, put it back into your checking account. Then, make a credit card payment as soon as you can, so you don’t accumulate any interest on that purchase.
You can also create an envelope for online purchases. This envelope will be empty at the beginning of the month. But, anytime you buy something from one of the other budget categories online, you will transfer that money to your online purchasing envelope. Then, at the end of the month, put all of that money back into your checking or bank account. Make sense?
A third affordable option is to use cash to buy a gift card to make online purchases. This is a good idea because you're still following cash spending and using budgeting envelopes, but you're capped at how much is on the gift card. This way, you'll be able to surpress any impulse buys and stop yourself from spending more money than you have.
Purchasing Several Items That Fall Under Multiple Budgeting Categories
This can be a little tricky. Let’s say you are making a Target run because you need several items. Lots of Targets have groceries, so you decide to pick up the eggs and bread you need for breakfast tomorrow. But, you also need shampoo and ink for your printer. The easiest thing to do when you are in a situation like this is to split the items into separate purchases. That way, you can use each designated envelope. You also might want to consider using the self-checkout to complete your transactions.
Different Cash Envelope Products
If you want to start using the cash envelope system, you can use your own envelopes (even the return free envelopes that come with bills in the mail!), buy fancy color coded envelopes, or even get a special envelope system product, like a cash envelope wallet or binder.
There are tons of great cash envelope products out there on both Amazon and Etsy. You can also buy one directly on Dave Ramesy’s website.
Cash Envelope Products on Etsy
Cash Envelope Products on Amazon
12 Piece Cash Envelope System for Budgeting
This budgeting set includes 12 cash envelopes, 12 budget sheets printed on both sides so you can organize your expenses, and 48 rainbow, black, and white to categorize.
Learn more >
12 Waterproof Budget Envelopes
Water and tear resistant, these envelopes come with 12 budget sheets to help you manage your money. Cute designs and perfectly sized to slip into a purse or wallet!
Learn more >
12 Tabbed & Laminated Cash Envelope System
This one's unique in that it comes with a tabbed organizer system, making it a great way to keep all your cash envelopes together in one place. Also comes with cute envelopes, budget tracker sheets, and stickers.
Learn more >
Using the Cash Envelope System Virtually
So, if you really don’t want to carry that much cash around, there is a way you can use the cash envelope system virtually. There are a couple of cash envelope apps that you can link your checking account to and then create virtual cash envelopes: Goodbudget and Mvelopes.
Left Over Money
If you find yourself with much money left over in any of your cash envelopes at the end of the month, then you rock! Seriously, it’s not easy, so good for you.
You can opt to roll this money over to the next month, so you have a little extra. You can treat yourself to a nice dinner. You can put the money in your savings account or sinking fund. You can put it towards paying off one of your credit card bills. The options are endless!
Shuffling Cash Around
One thing you really want to steer clear of is borrowing from your other cash envelopes. It’s so easy to say, “Well, I’m out of my grocery money, but I really need a bottle of wine, so I’ll just borrow $20 from my self-care envelope.” But, this is a slippery slope that can lead to overspending.
Plus, the whole point of the cash envelope system is to help you get your spending in check. It kind of defeats the purpose if you are constantly borrowing from your grocery budget amount to support your Amazon addiction.
Some costs are always going to be variable expenses. For example, my gas bill is different every month. I looked at my bill over the last year, and figured out what the average monthly bill is. I treat it like a fixed expense, and always set aside that amount every month. If I have extra, I set it aside for a future bill, or move it as needed.
Miscellaneous or Emergency Expenses Envelopes
Designating an envelope to cover miscellaneous or emergency expenses is a must. In fact, I recommend having one of each. These will really come in handy if something unexpected comes up, like a doctor’s bill or if you run out of money in your restaurant/take out envelope, but your electricity goes out, and you have no choice but to order from the Thai restaurant down the street.
Is the Cash Envelope System the Right Budgeting Tool for You?
At the end of the day, it really depends on your financial goals as well as your willpower. This system is a great tool for those who really need to curb their spending and really want to work on sticking to a particular budgeting method. If you want to start saving or paying down debt, it will help you accomplish those goals as well.
But, in order for the cash envelope system to really work, you have to do it right.
If any of you have tried the cash envelope system, I’d love to hear how it worked out for you. Just comment below.
A forty-ish web designer/developer by day, a budget & financial fanatic by night. I’m a mom, wife, avid reader, and DIY enthusiast who’s tracking our journey to debt freedom. Read More