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The Modern Envelope Budgeting System
Budgeting with an “Envelope System” but with a modern twist
How do you decide on where to put your money? You want to save but you also want to live a little. Don’t forget bills! And what do you do with expenses that you are anticipating?
There are so many budgeting systems in place, why do you need yet another one? My budgeting system is not really a new concept. Its been around for a long time. Zero-based budgeting and envelope budgeting have been espoused by many personal finance experts and for good reason: it works. However, as we move to a increasingly digital and cashless society there are many drawbacks to those systems. I found that they didn’t totally work for me. Almost but not quite. And its that “not quite” caveat that makes the budgeting fail.
I do have a disclaimer to add: if you are truly terrible at money or have an addiction of some sort that makes using credit cards and online shopping risky: DO NOT DO THIS! This is a system that works for me but I also don’t really have any major issues that make budgeting supremely difficult for me. I am just poor and busy. I don’t have time or energy to spend too much on budgeting or tracking my spending but I also don’t need to dig myself out of a huge pile of debt because of overspending or addiction. If you find that you are not like me, please check out some other great and amazing personal finance sites that that can really help you and find a budgeting system that works for you.
Anyways, after all the caveats and disclaimers. This is how I adapted the zero-based budgeting and envelope budgeting system into a more modern system.
I call it the Modern Envelope Budgeting System.
The best way to budget your money is to decide before you receive it where each dollar will go. This is a combination of various budgeting system- and it works!
This is a cash budget which means that you can only spend money you actually have. Some financial advisors will tell you to only use actual cash or direct deposits but I see no harm in using a credit card AS LONG AS THE MONEY NEEDED TO PAY FOR IT IS ALREADY IN YOUR ACCOUNT. I still recommend, unless you are great at self-control and are very good at keeping on top of the amount in your account, to use cash for discretionary spending- food, splurges etc.
The best way, in my opinion, to keep track of your money is to divide it into separate categories as soon as you get it. Some will tell you to take out the money and put it in a labeled envelop, hence the term “Envelope system” but in the modern era I suggest you open several sub accounts and just deposit the money in there.
CapitalOne360 for example, allows you to have many savings accounts that can be named whatever you want and can be accessed easily from your computer or phone. You can transfer money directly from your main checking account, so it’s easy to divide your paycheck. However, you can only withdraw 5 times a month from each savings account so keep track. If you do put purchases on your credit card, pay a bunch at a time, instead of each individual transaction so that you don’t use up your withdrawal limit.
Each person will have their own categories but here are some basic ones that I will discuss:
Basically, you divide your paycheck every month (or 2 weeks) into these categories and transfer them into the corresponding accounts. Some will be a fixed amount monthly and some will percentages.
So… this is how it works….
Charity- 10% right off the top. No need to think about this one. Put it another checking account or savings account and you can give it out as needed. When there is money in your Charity account you can feel comfortable giving a decent donation to a charity of your choice or be able to sponsor your niece in her ride-a-thon or give to a friend in need.
Savings- This should be approximately 15% of your paycheck but you should try to make it as high as possible, especially if your bills are low. It should definitely be more than your splurge or clothing account. You take this money and put it wherever you are on the Savings Ladder. (If you are working on emergency, you put it there, if you are up to retirement you put it there etc.) Please notice how you put the 15% immediately into your savings account (envelope) when you get your paycheck. You don’t put your leftovers in your savings account- this is what PAY YOURSELF FIRST means.
Bills- Take all your bills and add them up. If they sometimes fluctuate round up from an average month. Put that amount in your bills account. If there is leftover at the end of the month, it rolls over so when your electricity bill is higher in the summer, you have some extra money in the account to cover for it. The best part of this system is that when you get a bill you already have the money in your account to pay for it. No playing catch-up! No need to worry about whether you will have enough for a slightly higher bill. It is already in your account, just waiting for that bill to come. Talk about removing stress from bills!
Transportation- Take your gas bill or bus costs and figure out how much you spend approximately each month. Put that amount each month into an account and roll it over if there are leftovers. This makes sure that if one month you use more gas than you have extra money in the account to pay for it. If you have fixed transportation expenses, i.e. bus card, then you can combine this with your bills account.
Regular Maintenance- If you own a car or a house you should also put some money in here for maintenance. If you put in a small amount each month then when you need maintenance done on your car or home then you will have the money for it. Car problems don’t need to mean an emergency. (Although I am using a car and home as an example here, you can set up accounts for anything that you have that needs regular care).
Coming soon- This is the account that is for very short terms savings. You can also call this a holiday account. This is for things that come up every once in a while but not regularly. Examples are holidays, birthdays, weddings, and semi-big purchases that you will need or want, ex new computer or phone. Saving for these things mean that you don’t have to borrow or put money on a credit card when these expected expenses come up.
Clothes- This is the same idea as the “Coming soon” account. Put aside money each month for clothes, shoes and accessories. Although you may not shop each month, the money rolls over so you can shop freely when you want. This can also help you take advantage of sales- during an off-season you can buy clothes on sale without guilt because you have the money put aside for it!
Food/Discretionary- This account is for all the food, toiletries and day-too-day spending. This money can stay in your checking account because this is the money that you are spending every day. Again, if you have leftover money, roll it over into the next month. Having a set amount to spend on these items will make sure that you stay within your budget. When the money is running low-stop spending!
Splurge- This is the last account to be filled and the first one that gets cut out when things get tough. Obviously, each person will have a different idea of what gets paid from the splurge account, but this is the account for fun. This account get filled LAST. Although it is important to have “fun” this should not come at the expense of your financial security. Don’t skimp on savings, maintenance or bills for a little fun, especially when there are so many ways to have fun or take care of yourselves that are cheap or free. When you run into financial difficulties or are expecting a big expense and you don’t have enough saved up- this category should be the FIRST to go.
These are just examples of some of the accounts that I have (I also have one for property taxes and building fees, as well as some others) and each person will decide which accounts or envelopes they need. You may have accounts that change over time and you may need new ones as your needs evolve. The point is to have money to cover all your expense and anything that may come up. Planning for events and purchases that are bound to come up will leave you with security in knowing that the money you need is set aside.
This system is not new, it has been around for a while. I suggest (as written above) utilizing different online account instead of having actual envelopes which may got lost.
The most exciting part of using online savings accounts for some of the lesser used categories:
Interest! That’s right! for example, Capital One gives you interest on these savings accounts which means that your bill money can potentially MAKE you more money while waiting to be used. It won’t be a lot but every little bit counts!
The second exciting thing is Credit Cards. Many credit cards give great cashback or rewards for suing them. If you put a bill on your credit card THAT YOU ALREADY HAVE THE CASH FOR IN YOUR ACCOUNT you can get point and cashback while still staying out of debt and in control of your spending.
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Setting Up A Savings Ladder
Step-By-Step Guide to Savings
Where do you put the savings portion of your paycheck?
What do you do with the money you have made so far that you don’t know what to do with?
Welcome to the savings ladder!
The process is simple; when you complete one step you simply move up the ladder and do the next step. If you need to take money out of a ladder step, climb down one step and start over. The point is to continue moving up the ladder but if you have to take a step down- its ok! The ladder is made for climbing up and down!
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The Ladder Rungs
Life Happens Fund: Put away $1,000 in this fund. This money should be accessible to you in times of emergency. I used to call this my Emergency Fund but I have since changed the name to the Life Happens Fund. Because Life Happens and you can’t possibly plan for everything. It can be in a checking account or a simple savings account. You do not want it tied up in something that takes a while to withdraw or has penalties for withdrawal. I used to think that this should be for things that are only for Emergencies but I decided that this is really for things that you didn’t budget for because you couldn’t predict them or you didn’t know you had to budget for.
Really, you should try to budget for events as much as possible. For example, back to school expenses come up every year and therefore can be planned in advance. Holidays, gifts, clothes etc. should all be part of your budget and you should have an “Envelope” for each. Things like that should not be taken out of the Life Happens Fund. BUT… if you would otherwise go into debt for it then, by all means, take it out of this fund. This should act as a buffer between you and debt. This will help you cashflow unexpected expenses and keep you debt-free and able to handle life’s surprises. Hopefully, you will never touch this money- but if you have to withdraw money than immediately replenish the account so it has $1,000 in it.
Retirement: Take $6,000 and put in a Roth IRA (or SEP IRA if you are self-employed).
Why do I suggest putting money away for retirement as the second step?
There are 2 reasons for this:
1. Compound Interest- the earlier you put in money the more it grows and accumulates interest.
2. Usually, when things get tough (as they usually do) the first thing people do is lower their long-term saving contributions. By putting this money away now you are making sure that at least you have some form of long-term savings put away. The best way to financial plan is to assume that later in life you will have less money, not more. That way if that is true you have planned appropriately. If you do have more money later in life- you will just be richer.
IF YOU HAVE JUST GOTTEN A JOB, ESPECIALLY IF YOU DO NOT HAVE KIDS YET, THEN SAVE AS MUCH AS YOU CAN!
The easiest way to do this is to open a Targeted Retirement Account. Pick an account that allows withdrawals in the year you plan to retire (at age 59 1/2) and max it out every year as soon as possible. The maximum contributions are $6,000 for someone filing taxes independently. Keep in mind that just like all investment options -there are pros and cons to these accounts. In my own personal opinion, these are the easiest to “set and forget” for the uninitiated investor who needs to set up a retirement account- which you should do as soon as possible- COMPOUND INTEREST. So yes, if you are 18 year old, it’s not too early to start thinking about retirement.
Some accounts need a large minimum deposit in order to open. If you don’t have that kind of money, simply open a savings account such as Barclays or Ally and deposit the money in there. Once you reach the minimum deposit amount you can open your account.
I am not an expert on investing- so I won’t tell you what to do besides to open the account. But here are some links to help you get started!
3-6 Months savings: This is the “Emergency Fund”. Take all your expenses and multiply that by 6, or take only the bare minimum and multiply by 3. This is the amount that you need to have in this account. This savings should also be fairly easy to access. A simple savings account should do the trick. No CD’s or mutual funds. You are not going to make money off this account- you just want it there when you need it. Of course, if you can put it in a savings account that pays interest that will just work in your favor!
Intermediate Savings: What are your upcoming big expenses? Finishing your degree? Going to graduate school? Will you need to pay for a wedding? If none of these apply than you can just start putting money away for a house. This account should be a money-making account but you don’t want something too risky. A good mutual fund should do the trick. You want the money to work for you but you don’t want to take too many risks as you may need the money in the near future. Even if you don’t it’s a good idea to have money in an account that makes money but is not too risky. The amount that you out in this account will vary based on your needs.
The Sky is the Limit: This is where you can get creative and get rich. You have enough for school? For a wedding? For a down payment on a house (or getting there)? Start diversifying. Put your savings money in different brokerage accounts, mutual funds, CD’s, start trading etc. Never put all or most of your money in one place and don’t invest more than you can afford to lose.
At this point you are ready to start some real investing. I have not reached this point yet so I can only point you to the experts to help guide you. The Smart Investor has many great investing guides, like this one about How to Choose The Right Broker For Your Needs where they also break down the different types of brokerage accounts and what fees and limitations are involved with each one.