Planning your household budget using the envelope method? How does the envelope system work in home finance management? Is it more economical to pay in cash from an envelope than using a payment card?

You’ve just received a message from your h1b visa lawyer that you are going to live and work in the USA. You’ve probably been feeling on top of the world since then. You are now allowed to work here like a normal citizen, congratulations! But here’s come the tricky part. The first two or three months are going to be hard for you financially, especially if you are starting from scratch to fulfill your American Dream. As an economics student, I should probably be ashamed of it, but until recently I had never heard of the envelope method. I found out about it by accident, looking for inspiration to create another article. The idea itself is so interesting that I just had to devote some time and space to it. In this article I will explain to you what the envelope method is and how keeping money in envelopes can save it and help you survive.

When We Pay in Cash We Spend Less?

Of course, I am not the author of this hypothesis. What’s more, I don’t really like paying in cash. However, I cannot remain indifferent to the credible research carried out by experts from the American Psychology Association. They show that actually paying in cash is conducive to saving. How is it possible?

According to psychologists, there is a mechanism of discomfort, which we feel when we part ways with physical money. The sight of our file of banknotes at the cashier’s check out almost causes us physical pain. The effect? Subconsciously, we try to avoid such unpleasantness – so we are more willing to save and we think much more carefully about the sense of making a specific purchase decision.

A simple example: I have only 100 dollars in my wallet and I did not take my card. Usually I spend about 200 dollars on weekly grocery shopping. What am I doing? I set priorities. I resign from various cloggers, focusing only on what I really need. All this in order to stay within the limit. But let’s go back to that study by American psychologists. One of its elements was a test to which 28 people were subjected. Each of them received a detailed list of purchases. In the first stage, the extras paid with a voucher worth 50 dollars. Later they received a 50-dollar banknote. What turned out? By paying with a voucher, they spent more than in cash – because they chose more expensive products. Interesting, right?

A payment card fosters profligacy

It’s obvious that without seeing how much it really cost us to buy a specific product, we’re willing to spend a lot more on it. This is particularly evident in the case of credit card payments. Here, not only do we operate with virtual money, but also the consequences of its release are postponed. A credit card is a good solution, but only for people who can impose financial discipline on themselves. Otherwise, it will cause huge problems.

Hence the conclusion that if we have difficulties in managing our household budget sensibly, it is worth using cash more often or even relying only on it. Thanks to this we can see exactly how much we actually spend and literally feel the weight of every purchase we make. Here we come to the heart of this article. It is time to explain what the envelope method actually is.

Keep the cash in an envelope and you will live cheaper

The envelope method, as you can easily guess, consists of holding cash in an envelope, or actually in several envelopes. It’s kind of an old-fashioned equivalent of sub accounts. In each household there are specific groups of expenses:

  1. Accounts
  2. Rent
  3. Fuel
  4. Food purchases
  5. Pleasure

The idea behind the envelope method is to keep the money to finance these things in dedicated envelopes. And so: we create a separate envelope for bills, a separate envelope for groceries, a separate envelope for culture and other entertainment, a separate envelope for expenses related to the upkeep costs of owning a car, etc.

The question is, how do I actually know how much money I will need to meet all these needs? Here you have to rely on your experience. You can simply track the movements in your account and write down the scale of spending on different categories. If the average spending’s for the last six months show that, for example, you spend 200 dollars per month on fuel, this amount should be placed in a separate envelope.

Why all this? To spend less – according to the mechanism that I described earlier. Implementation of this solution is quite troublesome, because let’s not deceive ourselves – choosing which credit card is best for me and paying with it on a daily basis is a lot more convenient. However, you can break through and at least try to manage your budget using the envelope method. It’s Friday, the day of the weekly shopping. Instead of taking a wallet of cards with me, I only take an envelope with the amount deducted and I have to comply with this limit.

A simpler way to use the envelope method

I was wondering how I would actually work with all these envelopes. I imagined a very real situation when, for example, I go to buy some groceries, but already while filling the basket, I remember that the toilet cleaning liquid was running out. And what, should I go back home for an envelope with the inscription “Chemistry” on it? That would be strange, to say the least, and certainly not very practical.

I therefore came to the conclusion that it would be sensible to modify the envelope method a little bit and simply keep the money in one envelope for monthly household maintenance – a separate envelope could be used for the bills. This way I wouldn’t feel uncomfortable while shopping (no fear of running out of money).

I treat the envelope method only in terms of curiosity. However, it doesn’t change the fact that such a solution can be very helpful for people who do not have complete control over their expenses and need solid training in sound budget management.

What do you think about the envelope method? Have you heard about it before? Would you be able to comply with it?