Wednesday, September 24, 2008

Envelope Budgeting System

I was reading some personal finance blogs today, and came across this entry from Todd at Harvesting Dollars about using the envelope system to control overspending. For those of you unfamiliar with the envelope system, take a look at this brief explanation by Dave Ramsay. It's a simple and effective budgeting aid.

For some of us, the psychological impact of seeing the dollars as they trickle through our hands is an important part of controllong the flow. For me, and I hope many of you, the abstract notion of money flowing through the debit card or credit card is just as real as seeing all those Canadian Prime Ministers wave bye-bye as I make a purchase. So the physical envelopes of cash aren't a necessity, and in today's electronic world, there is a better way.

I use a virtual envelope budgeting system. I have two bank accounts at President's Choice Financial, a chequing account and a high yield savings account. The two combined are my 'wallet'. I've set up a spreadsheet with seven 'envelopes' represented by column headings such as 'house', 'food and utilities', 'car' and so on. Any transaction is entered into the spreadsheet and the totals in my 'envelopes' updated. Take a look here to see what I'm talking about*. If any 'envelope' goes negative, or is in danger of going negative, I analyze why. Is it a one time unexpected bill or a predictable expense I forgot to allow for? I adjust my budget accordingly and re-allocate my income to cover it.

Of course, for this to work in the long term, you need an accurate budget. The beauty of it is you can start with a rough budget. As time goes by some balances will climb higher and higher, indicating that you're budgeting too much money for this item, or conversely, balances will sink into the red indicating you need to allocate more funds here. So, over time, this tool can help you develop an accurate budget.

This method isn't necessarrily for everyone. Obviously, you need to have a working knowledge of how to use a spreadsheet program, and as mentioned earlier, actually physically seeing the cash in an envelope (or lack thereof) is a huge help in controlling the urge to overspend for some people.

*Some notes about the linked spreadsheet. It's an actual excerpt from my real spreadsheet I use everyday to run my budget. The 'house' heading includes a sinking fund (similar to an emergency fund) for house maintenance. 'Project', with a balance of zero for the time period shown, is an 'envelope' I set up to save up for some house renovations.

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