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A few months ago, I got into a discussion with a fellow financial coach about the cash envelope system.
I’ve always been a one-credit-card kind of gal when it comes to budgeting.
As a 20-something millennial, I’ve done the vast majority of my banking online. The last time I can remember using cash was when I worked as a server in high college. And even then I would deposit the cash bills and use my card.
The idea of carrying around cash always seemed like a burden — fumbling with coins, keeping track of receipts, counting change — so I’d never tried the envelope budget system.
However, this coach made a particularly compelling argument for why I should give it a shot.
He’s a self-made millionaire, long-time cash envelope user, and has counseled hundreds of people through paying off debt and getting control of their finances.
So I respect his opinion about this sort of thing.
Ultimately, I decided to try out the cash envelope system myself for two reasons:
- I love experimenting with new budgeting/money management systems. (Nerd alert!)
- It seemed like a great tool for my financial coaching clients to use. And in order to help them, I actually needed to use the system myself. Plus, the whole “practice what you preach” thing, you know? I can’t reasonably ask my clients to do something I’m not willing to do myself.
In this article, I’m going to share with you what the cash envelope system is, how to use it, and my personal experience with it (a financial coach’s perspective).
What is the Cash Envelope System?
The cash envelope system is a budgeting method where you set aside cash (in envelopes) for certain expenses. You use a different envelope for each category, and you’re only allowed to spend the cash in that envelope.
So let’s say you bring home $2,000 a month in after-tax income and you allot $300 per month for groceries. When you get paid, you would withdraw cash for your money envelopes. You could do $150 per paycheck, the full $300 from your first paycheck, or whatever setup works for you.
Why the Cash Envelope System Works
Before we talk about how the cash envelope system works, let’s talk about why it works — on a psychological level.
According to research, paying with cash is actually painful, and it causes us to value our purchases more. Handing over cash feels like more of a commitment. We’re physically giving something up in exchange for something else.
This forces us to further evaluate our purchases. According to Avni Shah, Assistant Professor at the University of Toronto, paying with cash also triggers pain receptors in the brain. This means we’re more likely to shop around, look for better deals, or not spend the money at all to avoid the pain of parting with our cash.
In a 2016 study, Shah and her colleagues concluded that paying with a card makes us feel less connected to our purchases. Therefore, we’re likely to spend more, or even overspend, than when we use cash.
A 2001 study had similar findings. MIT professors Drazen Prelec and Duncan Simester offered participants a chance to purchase tickets to a professional basketball game that had already sold out. They found that those who were asked to pay with a credit card were willing to pay significantly more than those who were asked to pay with cash.
Based on these studies (as well as others), it’s safe to assume that paying with cash has a different psychological effect compared to paying with cards and, as a result, can help us spend less.
How to Use the Cash Envelope System: Step-by-Step Instructions
Okay, now that you know why the cash envelope system works, here’s how you can start using it in your own finances.
1. Create a Budget
If you haven’t done so already, you first need to create a budget.
I like to refer to a budget as a “spending plan” (because no one like the word “budget”).
Your spending plan is essential to getting control of your money and achieving your financial goals. So before you jump into the actual envelopes, take the time to create an intentional plan for how you’re going to spend your money next month.
Start with your income, then list out your expenses and assign a number to each category.
I highly recommend using a zero-sum budget, especially if you feel like you’re currently living paycheck to paycheck or trying to pay off debt. But really, I think it’s a great way to budget that works for most people.
The idea of the zero-sum budget is to assign every dollar a job. Start with your income, list your minimum savings goal, then normal expenses, and debt payments. Anything left over goes to your next financial goal (emergency fund, paying off debt, etc.).
As a general rule of thumb, I recommend being conservative in the first month (or two or three) of your budget. By that, I mean don’t go slashing categories just yet. Budget on the higher side of what you think you’ll spend. That way you’re less likely to overspend, become discouraged, and not make it to month two.
First get control, then look for ways to save money.
2. Choose Your Cash Envelope Categories
Once you have your budget down, go back through and choose the categories you want to use for your cash envelopes.
Anything that’s “unnecessary” or discretionary is prime cash envelope territory. However, I also use envelopes for things like pet food, groceries, and gifts.
For regular monthly bills (rent, utilities, Internet, phones, student loans, etc.), I prefer to keep cash in my checking account and pay those online or by check. I also use a debit card for gasoline.
Some common cash envelope categories include:
- Eating Out
- Doctor Visits
- Hair Care/Salon
- Fun/Spontaneous Money
Of course, your cash envelope categories will depend on your personal situation.
3. Break it Down by Paycheck
To successfully use cash, you’re going to need to plan ahead. Go back to your monthly budget and break down each spending category by pay period. How much will you have in your envelope from paycheck 1? Paycheck 2? And so on.
This will require a bit of a time investment up front to figure out which expenses to pay from which check, but if your pay is consistent, it’ll be easy to update and maintain from month to month.
Personally, I like to fully fund each of my cash envelopes at the beginning of the month. That way if I find a good deal on something — groceries, for example — I can buy in bulk and not have to worry about busting the budget for that pay period.
If you’re not able to do that right now, or just prefer not to, then no big deal! The great thing about the envelope system is that you can tweak it to meet your specific needs.
4. Figure Out Your Bills
The last thing you want to do is get home from the bank and realize you need to split a $50 between three envelopes. Before getting your cash, break down each envelope by the types of bills you want.
For example, if you have the following envelopes:
- Groceries: $200
- Fun Money: $50
- Entertainment: $30
- Eating Out: $75
Then your bills might look like this:
- Groceries: 5 x $20, 7 x $10, 6 x $5 = $200
- Fun Money: 2 x $20, 1 x $10 = $50
- Entertainment: 2 x $10, 2 x $5 = $30
- Eating Out: 3 x $20, 3 x $5 = $75
You can jot this down on a piece of paper and hand it to your bank teller to make things easier.
5. Set Up Your Envelopes
Once you’ve got a plan in place, it’s time to set up your envelopes. You can be as fancy or as simple with your setup as you like.
I just use plain white envelopes, but if pretty envelopes encourage you to stick to your budget, then go for it!
6. Spend Your Cash
Following through with your envelopes takes discipline.
If you get to the grocery store and realize you forgot your envelope, turn around and head back home. It’s an inconvenience, but once you forget your envelopes a couple times and have to make the extra trip, you’ll start to get in the habit of grabbing them before you go.
One way to ensure you stick to your envelopes is to take your cards out of your wallet and leave them at home. Without the temptation of whipping out a card, you’ll be more likely to stick to your new cash system.
Likewise, if your grocery total comes to $207.51 and you only have $200 in your envelope, put something back. This may be tough at first, but it will help you to plan ahead. It also forces you to make some difficult decisions and reevaluate your spending.
Finally, get into the habit of asking for and hanging onto your receipts. Tuck them away in your envelopes and use them to update your “actual spent” section of your budget at least once per week. That way you can track your spending and use it to plan for the weeks ahead.
Pros and Cons of the Cash Envelope System
No system is perfect, including cash envelopes. While I personally believe the pros outweigh the cons for the majority of people, here are a few things to consider.
Pros of the Envelope Budget System
It works. Speaking from personal experience and from what I’ve seen with my financial coaching clients, the cash envelope system does what it’s supposed to do — help you stay on track with your spending.
Helps cut back on impulse purchases. When you put away your cards, commit to using cash, and limit the amount at your disposal, it becomes more difficult to spend impulsively. If you want to buy something, you have to physically go get it, run to the bank and deposit cash to buy it online, or at least dig up your cards. This usually allows enough space for you to reevaluate the purchase rather than blindly entering your credit card information.
Increases the likelihood of follow through. Again, this one is based on personal experience and the results I’ve seen with my clients. Using cash makes your budget feel more tangible. Every time you reach for an envelope, you’ll be reminded of your budget, and you’re more likely to stay within your self-imposed limits.
Avoid overdraft fees and taking on more debt. An obvious perk of not using cards is that you don’t run the risk of over drafting your account, and you’re not adding to your credit card debt.
Cons of Cash Envelopes
Inconvenient/not always practical. My least favorite thing about the cash envelope system is that it’s inconvenient. No one wants to carry around cash or run back home to grab an envelope when you’re already at the store. However, I also consider this a benefit, because you’re less likely to spend money when it’s inconvenient.
May feel clumsy at first. If you’re using cash envelopes for the first time, it can be a bit confusing. At face value, it’s straightforward, but you’ll likely encounter situations where you’re not sure exactly how to use your envelopes. It may take a few months to work out the kinks and refine your envelope budget system.
No credit card rewards. Many people sign up for credit cards specifically for the rewards and bonuses they offer. When you switch to cash, you’ll miss out on those perks.
My Results Using the Cash Envelope System
As I said earlier, I’m a lifelong credit card user. I got my first credit card on my 18th birthday and have been using them ever since.
I’ve always been fairly responsible with my spending, even as a teenager, and I like taking advantage of credit card rewards. All in all, I didn’t think switching to cash would be very beneficial for me, if at all.
But I was wrong.
Insight 1: I spent less money.
My first month using the cash envelope system, I didn’t overspend in a single category. I even allotted just $40 to eating out — which is on the lower end for me right now — and I only spent about $30.
I already set aside money every month for savings and put extra towards my student loans. But when I switched to cash, I had additional funds left over to put towards my goals.
Insight 2: I saved more money.
Rather than spending my leftover cash at the end of the month, I put it in a new envelope labeled “Deposit” and stuck it in the bank to help reach my short-term savings goals (car tires, vacation, etc.) even faster.
I could have taken the money and treated myself with it, but I felt so excited about having the extra cash that I just didn’t want to spend it.
Insight 3: It was noticeably more difficult to spend money.
Even for someone who doesn’t have a history of overspending, I noticed that my spending levels decreased. It was tougher than I imagined to let go of my cash, especially for bigger purchases.
Every time I bought groceries I cringed a little handing over those bills and feeling my envelope get thinner and thinner. I analyzed every purchase and even stopped treating myself to my usual splurges like Larabars and potato chips.
Note: Using cash doesn’t mean you can’t splurge or treat yourself. This was just my personal experience.
Will I continue using cash envelopes?
After month 4, I actually switched back to my one-credit-card system to see if anything changed.
It did. Namely, the amount left over at the end of the month.
My average cash left over for those four months of using cash only was $177. After one month of using my credit card again, that number dropped to $0.81.
Granted, I had some additional travel this month, so that had an impact on my numbers. I’m going to give it another month or two to see how things go, but I foresee I’ll be switching back to cash envelopes.
However, I’m thinking I’ll cut back my envelopes to just 2-3 categories: eating out, fun money, and miscellaneous.
I’ll update this section when the results are in.
Cash Envelope System FAQs
Like I said, cash envelopes can be confusing at first. You may have a few questions already, so I’m going to attempt to answer those first.
(If you have additional questions, be sure to leave them in the comments!)
What do I do if I’ve spent all my cash and still need money?
Whatever you do, DON’T pull from your other envelopes, if you can help it.
The answer here depends on the category. Ideally, if you run out of money in your envelope, you would wait until the next paycheck or month rolls around to fund it again.
If, however, the category is groceries or another essential, that might not be possible. This is your chance to be creative. Dig around in the cupboards and look for ways to use what you already have.
If you notice you’ve overbudgeted in another category, you can take funds from that envelope, but only once. You don’t want to get into the habit of shifting things around and “cheating” on your envelopes — that defeats the purpose of the system.
The best way to handle this type of situation is to prevent it from happening in the first place. In other words, be realistic with your budget. Plan for more than you think you’ll need in the beginning so you don’t run the risk of falling short. You can always adjust your numbers in future months once you see how much you normally spend.
Where should I keep my cash envelopes?
Some people are wary of carrying around too much cash or keeping large amounts in the house. I keep my envelopes in a basket in the bedroom, but I understand that’s not comfortable for everyone.
The safest place to store your cash at home is probably a fireproof safe. If you don’t have one at your disposal, then you may consider purchasing one or hiding your money in an inconspicuous place.
How do I use cash envelopes with my debit card?
There are a few different ways you can do this. What I recommend for my coaching clients (at least in the beginning while you’re getting spending under control) is to:
- Take cash out of your envelope.
- Deposit it into your bank account.
- Make your purchase online using your debit card.
For bills and automatic payments, you can leave the cash in your checking account. They probably don’t need an envelope.
What do I do with extra cash at the end of the month?
If you have money left over in your envelopes at the end of the month — awesome work! It’s totally okay (even encouraged) to reward yourself for your efforts.
That doesn’t mean go crazy — you still have goals you’re working towards, after all. But by all means, take yourself out to dinner, host a small get together at your house, go see a movie, get a manicure. Whatever it is that makes you feel good.
Rewarding yourself is important because it helps you stay motivated. The same goes with reaching your goals — don’t forget to celebrate the small victories!
Customize the Cash Envelope System to Work for You
The cash envelope system can work for anyone, but it’s a must if you’re living on a low income or have a habit of overspending or impulse buying.
From what I’ve seen, the cash envelope system works. Carrying around cash may seem old-fashioned, but it has the potential to drastically reduce your spending and help you stick to a budget.
It also helps you take a step back and be more intentional about how you spend your money.
And, remember, nothing is set in stone. If there’s something about it that doesn’t work for you, or if you’d prefer to go half envelopes, half digital, then you can always customize it for your situation. In the end, you have to do what’s best for you and your budget.
Have questions or want to share your experience with the cash envelope system? Leave them in the comments!
I’m a financial coach and author + owner of Goodbye to Broke. I love all things personal finance, money management, and healthy living. And I talk to my dog way too much, if we’re being honest.