Your Money_ The Missing Manual - J. D. Roth [24]
Envelope Budgeting
The envelope budgeting system is a simple method that you can use with any sort of budget to help you manage your spending. The basic process is this: When you get paid, you put cash in various envelopes designated for specific budget categories. Here's how it works:
Choose your categories. You should have one envelope for each category you plan to track. Write the category's name on each envelope.
Set money aside. After you deposit your paycheck, withdraw cash for each budgeted category. So if you've budgeted $200 for groceries, put $200 in your Grocery envelope and note the amount on the back.
Spend as usual. Throughout the month, take cash from the envelopes to make your purchases. Write your withdrawals on the back: If you spend $77 at the grocery store, note that you have $123 left for the pay period. After you buy something, put the receipt and the change back in the envelope.
When an envelope is empty, you're done. If you run out of money in an envelope, you have two options. Hardcore budgeters argue that you should suck it up until your next paycheck rolls around; once you've spent your entertainment budget, that's it. ("How else will you learn discipline?" they ask.) Others say that it's okay to take from one envelope to fund another. Whichever route you choose, the important thing is not to resort to credit—that would defeat the whole purpose of this cash-based system.
Decide what to do with the leftovers. At the end of the pay period, if you have money left in an envelope, you can leave it there to bulk up that category for the next round. Better yet, use the surplus to pay down your debt or make a deposit into long-term savings.
Do it all over again with your next paycheck. If you discover that you always have a deficit or surplus in certain categories, adjust your budget accordingly.
Tip
This YouTube video does a fantastic job of explaining envelope budgets: http://tinyurl.com/envelope-budget. The Frugal Dad blog has a more in-depth explanation of the system: http://tinyurl.com/frugal-envelope.
You can use this method whether your budget is simple or complex. If you don't want to hassle with actual envelopes—or carry around large amounts of cash—check out Mvelopes (www.mvelopes.com) or YNAB (www.youneedabudget.com), software that lets you manage your budget using virtual envelopes; learn more on Web-Based Tools.
Think Yearly
If you're having a tough time staying within your budget, the problem could be that you're trying to predict your spending over too small a time frame. A study published in the Journal of Consumer Research in August 2008 found that folks who made annual budgets did a better job of predicting what they'd spend than those who made monthly budgets.
Yearly budgets are more accurate because people consider more expense categories when thinking long-term. If you build a monthly budget in April, for example, will you remember to include a category for Christmas gifts? If you instead take the whole year into account, you'll remember to include stuff like that.
The downside of yearly budgets is that they aren't very useful for planning day-to-day spending. The solution is to get the best of both worlds:
Create an annual budget first. It's easier for most people to estimate yearly expenses than monthly ones.
Make a monthly budget based on your annual one. Once you have your annual budget, divide the estimated expenses in each category by 12 to get monthly numbers.
Voilà—you've got yourself a monthly budget that takes seasonal expenses into account.
Automating Your Budget
Whether you use a simple budget or a more detailed one, do yourself a favor and automate the budgeting process.
The past two decades have seen a revolution in personal finance. It used to be that you had to balance your