Dave Ramsey’s Envelope System Explained: Pros, Cons and Alternatives

Grab four quarters from your car’s ashtray and make a quick trip to the discount store and you could immediately begin a budgeting system that can revolutionize your financial fortunes and keep you out of debt.

Even better, you can start for FREE with a few sheets of stationary paper and a staple gun.

Sound too good to be true?

It’s grandma’s “envelope system of household budgeting” though you may never have heard if from Grandma. It really was made famous (and a lot more popular) by finance guru and radio talk show host Dave Ramsey. All you need to get started are some ordinary envelopes, either store bought or homemade.

Oh, you also need to mix in some financial discipline. You’ll definitely need that. Lots of it, actually. It’s the whole point of this exercise. Envelopes are simply a means to that end.

The envelope system is based on the whole psychology of people spending less when using cash instead of plastic. You are far more restrained in your spending when you pull money (not plastic) out of your wallet.

That’s one of the biggest benefits to stuffing cash into envelopes for budgeting purposes. It forces you to think twice … and maybe the second thought is that you don’t really need that item, after all.

You should know that the envelope system is far from a slam dunk strategy. In a society that is rapidly moving to cashless commerce, it might not be practical to stuff currency into envelopes. Who really wants to carry a wad of cash anyway? There are apps and other online tools that can accomplish the same objectives.

Still, the budgeting envelope system is one way to take (disciplined) control of your finances. Here’s a closer look at how it works:

What Is Dave Ramsey’s Envelope System?

The envelope system is a way to force yourself to accurately budget discretionary expenses every month. It demands honesty, discipline and commitment, but the reward is that you gain control of your finances.

Let’s start with your salary. Assume you get paid twice a month with a total take-home income of $3,000 during that period.

Then you budget $500 a month for groceries, or $250 per paycheck. When the month’s first paycheck is deposited, go to the bank and withdraw $250. Put that cash in an envelope and label it “Groceries.’’

Every time you purchase “groceries” it must be with money from that envelope and only that envelope. If you go to the grocery store and realize you don’t have your envelope, you don’t whip out the credit card or debit card for payment. You go home and get the “Groceries” envelope. Yes, really. That is discipline.

Remember, you can ONLY buy groceries with the cash in that envelope. So, if your bill hits $251, guess what? You must put something back. There’s no wiggle room — NONE!

Once the money is gone from your “Groceries” envelope, you’re done until the next paycheck arrives. This system is how you find out how accurately you budget and how much money you really are spending on … groceries!

When you get your second paycheck of the month, withdraw another $250 and refill the “Groceries” envelope.

Next step is to identify all your monthly discretionary expense categories and make an envelope for each of them. Ramsey suggests using different colors for each envelope to avoid any confusion, but as long you label everything, you should be all right.

The categories in Dave Ramsey’s Budget might include:

• Gas
• Eating Out
• Entertainment/Movies
• Clothing
• Beauty/Grooming
• Hobbies

Your other bills – mortgage/rent, car payment, cell phone charges, cable television charges, electric bill and others — are fixed expenses. They can be put on autopay from your checking account because these expenses are unchanged and you don’t need constant bank trips to drain your checking account for every fixed expense.

So, what can go wrong? Plenty!

Not everyone spending money in your household is going to have the same discipline you will show with the envelope system, so here are some quick fixes to keep the system working.

» Learn More: Do Dave Ramsey’s Baby Steps Actually Work?

What if my spouse does some of the grocery shopping?

Sounds logical. Maybe your husband or wife will make a quick grocery run after work — when you have the Grocery envelope. The fix: When you begin with your initial $250 grocery allotment, put $200 in an envelope for you and $50 in an envelope for your spouse (or go $125 and $125 … whatever works).

What if I’m tempted to “borrow’’ from other envelopes?

This is like dieting. No one can make you stick to a diet or a budget. It requires planning and self-discipline. You should learn quickly about your weaknesses in the budgeting process and adjust accordingly. The fix: Only make purchases when you have the right envelope in your hand. If you can’t stick to the all-cash envelope system, leave the other envelopes (and your debit/credit cards) at home. Don’t stray from your purchasing plans and the overall budget.

What if I spend all of the cash?

Well, if you have realistically projected the needs for all the envelopes, you win! The probably won’t happen for a few months, but the envelope system should change your spending habits — if you have discipline. If not, what’s the point? The fix: Keep a miscellaneous spending envelope. That can cover an unexpected event like a birthday present or an overrun in another category. Money always will be limited, so self-control and discipline are non-negotiable items.

What if I do everything online and don’t carry cash?

The envelope system can still work, but in a different way. Remember, the idea behind carrying limited physical cash is simply to control how much you spend, almost utilizing it as a quick visual. The fix: Keep money in your bank account, but list expenses on your envelope. DO NOT spend more than what you allocated. It might require even more willpower, but the principle remains the same. Once you hit budget for that month, you’re done. There’s no more money to spend.

Can Anyone Use the Envelope System?

Using the envelope system carries a major assumption — that you already have enough money in your bank account to divide cash into envelopes when the month begins.

But according to the Harris Poll, 78% of Americans are living paycheck to paycheck, including almost one in 10 who earn more than $100,000 annually. More than half of Americans (56%) save $100 or less per month.

Meanwhile, according to a Bankrate survey, 57% of Americans don’t have enough cash to cover an unexpected expense of $500.

Obviously, if you are using this week’s paycheck to settle last week’s spending, you aren’t getting ahead. Here are some ways to put yourself in better position for using the envelope system:

Spending Doesn’t Equal Happiness — Making more money to buy more stuff doesn’t equal happiness, according to Harvard University professor Daniel Gilbert. He said a certain level of income can achieve comfort, somewhere in the per capita range of $50,000 to $75,000. After that, Gilbert said higher-income people are generally wasteful with their spending. He said people are happiest when their minds are engaged — or even when they’re giving money away instead of spending it on themselves.

When we splurge on something — say, the latest electronic gizmo or a really lavish dinner with friends — it can bring a momentary burst of happiness. Then it mostly gets forgotten. But if we don’t have enough money to feel secure or make ends meet, a splurge becomes a sensation to be remembered.

Find Fun Activities That Don’t Cost Money — Do you love to read? Go on hikes? Visit a park? Play board games? Watch television? Well then, do those things! They’re a lot better for your wallet than a big-time restaurant or theme park.

You derive pleasure from doing things, not buying things. Yes, there are shop-a-holics and people who swear by a little retail therapy. But those feelings are generally short-lived. If money is tight, there will be regret. Enjoy the things you already have. Or become an expert in free activities.

Don’t Get Sucked in by Advertising — Almost everything in our culture can confuse the definitions of needs and wants. At every turn, we are lured by products we don’t need. We question our lifestyle. We are tempted to try that new pricy restaurant. We might secretly want to spend more than we have on some frivolous item, but it’s not what we need. Know the difference.

Get Happy by Saving Money — There are few things more depressing than having a poor financial outlook. Worry leads to panic, which sometimes leads to a meltdown. It’s far more efficient to organize your money and use it efficiently, eliminating waste (and worry) from your life. You might find that the absence of financial worry also means the reduction of stress in your life.

Drastically Cut Your Expenses — What happens if you cut out everything that isn’t essential? Move to a smaller place. Get a less expensive car. Cut out your cable bill, your cell phone, your internet. Eat at home. Find some hobbies that are free.

How can anyone live like that?

Well, give it a try. You might like it. If you don’t? You can always add back those things that have been cut. What have you lost? Nothing. And you’ve gained knowledge.

Is the Envelope System Safe?

Welcome to the 21st century, the land of PayPal, ApplePay, credit cards, debit cards and … cash?

Not so fast on that last one.

Transactions these days are largely handled with a quick swipe or the punching of a few buttons on your mobile device, not reaching for your wallet and sifting through a wad of bills. Let’s face it, many people don’t feel comfortable carrying cash, especially the millennials who grew up in a largely cash-less society.

So what to do if you choose to employ the envelope system?

Safe Ways to Carry Cash

Obviously, there have been skilled pickpockets as long as money has existed, so keeping money secure is not a new issue.

Some ideas on where to hide the money:

• Distributing currency around your body
• Soft zip-top pouches or hidden cloth pockets sewn into clothing
• Stashing the bills between the insole and bottom of a shoe
• Money belts (or “bra pockets’’)
• Messenger bag or cross-body bag that can be worn across the front of your body

Some more common questions about the envelope system:

How Much Money Should I Carry?

And the answer is … all the money that you will need to make the “budgeted” purchase. The envelope system forces you to examine purchases, so a little thought and pre-planning will enable you to bring the right amount. Again, this is about deliberate purchases, not impulse buying.

What If I Have Leftover Cash at the End of the Month?

Ah, here’s a fun one. If you come in under budget, it’s OK to celebrate and reward yourself … within reason. Why not have a fancy dinner or a nice latte? Rewards can keep you extra motivated. You can also roll over the money to next month, so you could have an extra-large grocery budget. That’s another reason to celebrate.

What If I Run Out of Cash in One of the Envelopes?

This is important. You shouldn’t “borrow’’ from the other envelopes. That defeats the purpose of this system. Here’s a novel solution: Suffer a bit.

The envelope system’s purpose is to control your spending and help you stick to your budget. If one envelope is getting low, you might need to cut something back — or do without – until the next paycheck.

It’s possible you have miscalculated how much is actually needed per month for certain items, so you are allowed to adjust your figures, but only once. Don’t get in the habit of shifting them around.

Why Cash Only?

There are modern alternatives to using cash with the envelope system, but there’s research on how using cash actually makes you spend less.

According to Avni Shah, a professor at the University of Toronto Scarborough and Rotman School of Management, paying with cash triggers different pain sensors in the brain. Using cash encourages consumers to shop around, look for deals and spend less. Meanwhile, swiping a card encourages consumers to spend more.

Shah, in accord with researchers from Duke University and the University of North Carolina during a 2016 study, concluded that credit/debit cards are excellent for convenience but they make consumers less connected to purchases.

“That convenience may come at a price,’’ Shah said in a University of Toronto Scarborough article. “You feel something when you physically part with your money, and there are different levels of pain depending on the type of payment. Something tangible like cash will feel more painful to part with than paying by (check), which will feel more painful than paying by card and so on.’’

There are many other studies that back up Shah’s findings.

A 2012 study by University of Utah professor Promothesh Chatterjee and University of South Carolina professor Randall L. Rose pointed out that consumers who use credit tend to focus on the product’s benefits instead of its costs.

In 2001, Massachusetts Institute of Technology professors Drazan Prelec and Duncan Simester randomly selected participants who were offered the chance to purchase highly sought tickets to a professional basketball game that had just sold out. Some were told to pay by credit card and others were told they had to pay cash. On average, those who paid by credit card were willing to spent twice as much as those who paid with cash.

Or as Cornell University economics professor Robert Frank once said in a National Public Radio interview: “Parting with it (cash) is just a more vivid sensation than the abstract act of signing a pledge to pay sometime later in the future.’’

Pros and Cons of the Envelope System

Like anything, there are pros and cons to the envelope system.

Pros: It forces you into a disciplined budgeting system. It requires pre-planning before shopping excursions, instead of going to a store blindly and falling victim to impulse purchases. When you’re out of cash in the envelope, that’s it. You can’t overspend. Plus, you avoid the overdraft and fee penalties associated with careless card swiping.

Cons: Carrying cash is not a practical system for some consumers. The use of credit/debit cards give an automatic and exact system for tracking purchases, which can’t be replicated by using cash. Cards also allow you to accrue points and have cash-back options with purchases, a great option if the disciplined spending is utilized.

Alternatives to the Envelope System

The guiding principle of the envelope system — setting aside a specific sum for items such as groceries — can be replicated without having to carry cash.

Here are some alternatives:

The Clip System: OK, this isn’t very modern or much different than the envelope system, but it’s a bit less clunky. Instead of envelopes, you use clips, which allow you to actually see the divided money. It’s easier to fit into your wallet. You could use different colors and designs to help separate the categories. But like the envelopes, when the money is gone, it’s gone.

Mvelopes: The budgeting app Mvelopes utilizes many of the envelope system principles. It allows you to set aside money in advance and spend from how much is remaining in a selected category. When the money is running out, you are faced with choices — no purchase, buying something less expensive or moving money from another category.

Goodbudget: The Web site and mobile app Goodbudget allows consumers to allocate their money into different categories and track their spending. For an additional fee, consumers can get a more intricate system.

Most of the sites/apps, as a matter of course, will recommend the 50/30/20 system of budgeting. That means putting 50% of your after-tax income toward your needs (such as rent and groceries), about 30% toward wants (such as traveling and eating out) and about 20% toward savings and debt repayment.