1.4.4 The envelope system

Another method for managing your cash flow and your spending is the envelope system. The advantage of the envelope system is that the money is allocated in advance, so there are pre-set limits to how much you can spend in any one category each month.

How to set up an envelope system

Rashida puts money into envelopes labeled with expense categories.
  1. Look at the total income you have available each month.
  2. Withdraw your fixed monthly expenses: savings, debt payments, rent or mortgage, insurance, utilities, etc. Set this money aside before you allocate funds to the envelopes.
  3. With the remaining funds, estimate how much you will need for major expenses like food, transportation, household, clothing, etc. for the month. (It will be helpful if you have tracked your spending for the last few months.)
  4. Label an envelope for each spending category. (An alternative is to use glass jars.)
  5. Divide the monthly total for each category by four and place that amount in the envelope at the beginning of each week.
  6. Although the amounts in each category may be rough estimates at first, you can adjust them as you get more experience. You can also add envelopes for special projects and additional categories, as needed.
  7. During the week, record the actual expenses on the envelopes to gather data for future use. At the end of the week, review the amounts you actually spent in each category. Each month, adjust the allocations as needed.
  8. Of course, the challenge is to stick to the amounts in the envelopes! Remember that spending more in a certain category is not an excuse to increase the allocation for that category. The point is to stay within the limit and to adjust the amount only if necessary.
  9. If you find that you have money left over in one envelope, consider adding it to your monthly savings. You may add to the funds in another envelope, but don't spend more than the money you have available.

For example, suppose that Rashida has a monthly take-home pay of $2,100. After transferring $200 for debt repayment, $200 for savings, $700 for rent and $350 for monthly bills (including a transit pass, telecommunications and utilities), she calculates that she will need the following amounts for her monthly variable expenses:

Dividing each amount by four, she sets up envelopes with her weekly amounts:

Now she will have to see if these amounts are realistic. If she needs to spend more on clothing, for example, she may have to take some money out of the entertainment envelope. If she needs to buy a household appliance, she may have to cut back on eating out.

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