Have you ever felt that no matter how hard you try, sticking to a budget is like trying to hold water in your hands? Do you struggle with mental math at the cash register wondering if your new jacket exceeds the 7.37% of monthly income line item you have on your spreadsheet budget? Enter the (electronic) envelope system – a method that’s as tactile as practical, ensuring that every dollar is corralled for a specific purpose. Let’s dive into why the envelope system might just be your budgeting breakthrough!
What is the Envelope System?
The genesis of the envelope system was a straightforward way to manage your monthly budget by using physical envelopes to represent different categories of your spending. It’s as simple as labeling each envelope with a category like groceries, entertainment, or utilities and only spending the cash you’ve allocated for each. Many also believe that handing over physical cash increases the friction of transactions and prevents frivolous spending. In today’s technological environment, you may find it impractical to visit a brick-and-mortar bank to withdraw large sums of greenbacks when DFAS thanks you for your service on the 1st and 15th of each month. Enter the Electronic Envelope system.
What is the Electronic Envelope System?
Many of the large banks and credit unions now have user-friendly mobile banking apps that bring the bank teller to you. Customers can view balances and transfer funds between accounts in the palms of their hands. By establishing multiple individual and joint accounts, you can create “envelopes” to shuffle your funds into purpose-specific accounts. I use USAA for most of my banking, and there is no charge for opening new accounts. Between my own accounts and the ones I share with my wife, I have 11 accounts. I also have a 12th account with a High Yield Savings Account where we park our emergency funds (out of sight, out of mind, and a 5.00% APY!).
Why so many accounts?
Each account has a purpose. My LES is directly deposited into the main account each payday. From there, I transfer funds according to the Cash Flow Plan I developed with my wife. Your unique budgeting needs and goals dictate the number of accounts and amounts to fund them with – but that is a wholly different topic. I will share my basic structure.
Types of Accounts
Our Joint Checking account is funded to cover our fixed, recurring shared bills such as mortgage payments, electricity, insurance, etc. There are a total of 15 expenses that we pay out of that account each month. Over time, we learned how much we need to allocate for those categories and generally adjust the amounts each year in January. We leave a small buffer of funds in that account just in case a bill is larger than anticipated.
Another account is our Miscellaneous Spending account, which is for variable spending, such as groceries and the odd expenses that pop up for our children. We tracked our grocery bills for a period to help set a baseline for how much to contribute to this account, and now we use that limit as guardrails to control our shopping.
Next, we have a checking account titled Rental Checking into which we mobile deposit the rent checks from our tenants. We use these funds to pay the mortgage and any expenses related to the rental property, which makes filling out Schedule E much easier during tax season.
We use separate savings accounts for separate goals. Foremost is our emergency fund, which is held outside of USAA. It is funded with several months’ worth of expenses, and given the larger balance, we wanted to take advantage of the highest APY. Having this account largely out of sight also reduces our temptation to spend the money on non-emergencies.
We have a short-term Joint Savings account and contribute a small amount to each paycheck to handle unexpected expenses. Finally, we have a Sinking Fund account to make small contributions throughout the year for larger planned purchases (mainly summer camps for our daughters).
After Set Up
Once the framework is set up it requires just 2 minutes each payday to make the established transfers. I have complete autonomy to spend the remaining funds without guilt as I have already:
- Funded my retirement goals under my TSP and Roth IRA contributions first (alongside my wife’s 403(b) and IRA contributions).
- Funded our necessary savings and emergency funds.
- Set aside the funds to cover my liabilities and expenses.
Why Use This System?
Disciplined Spending: Once your primary/remainder account is empty, your discretionary spending is done until your next paycheck, which forces you to stick to your budget with clear limits.
Immediate Feedback: You get a real-time visual representation of your remaining budget, helping you adjust your spending habits on the fly. You won’t have to factor in upcoming bills with your spending habits as you will have already sequestered that money aside during your transfers.
Savings Incentive: Any money left over in an account can be redirected to savings/investments, debt repayment, or rolled over to the next period. This is an immediate reward for frugal spending.
How to Implement the Envelope System
- Determine Your Categories: Start by listing your regular expenses such as rent, food, gas, and entertainment are common categories, but tailor to your lifestyle. Determine the categories you need and contact your bank to open those accounts. If you share expenses with a partner, make sure they have access to deposit and withdraw.
- Set Your Budget: Consider your income and expenses to decide how much to allocate to each account. Be realistic and adjust as needed, or at least annually. Divide the annual amount into 24 (or 26 civilian) pay periods.
- Fill Your Accounts: After each paycheck, fill your various accounts with budgeted amounts.
- Spend Like You Have a Plan: Stick to the limits you have set for each category and fund. It can be as simple as using a dedicated credit card to transfer funds out of the appropriate category. Then park them in a short-term savings account until the bill is due. Bonus: you can accrue credit card reward points but avoid finance charges by paying in full each month!
Wrapping Up
The envelope/transfer system isn’t just about controlling spending; it’s about taking charge of your financial future. It reminds you of your goals and the path you’re taking to achieve them. It takes the guesswork and pressure out of discretionary spending and paying bills while working towards other financial goals.
Remember, financial freedom isn’t an overnight achievement. It’s the result of consistent, mindful decisions. Having a plan for each dollar may seem small at the moment but can build into tremendous savings over time.
How Do I Optimize This Strategy to Meet My Goals?
Hopefully, this article has given you ideas for what kinds of accounts you want to establish and how to divvy up those DFAS deposits. At the end of the day, the system is just a framework for you to apply your unique situation.
If you need help figuring out how your goals, expenses, and petty funds should be configured, it may be time to tag in a trusted Financial Planner. Reach out and connect with an advisor at the Military Financial Advisors Association!