8 Critical Mistakes in Envelope Budgeting

Envelope budgets are the best thing since sliced bread–if you’ve read this blog for any period of time, you know that I honestly believe that. An envelope budget can fix a big spender, heal money fights, and point you in the path of earlier and bigger financial success than you even dreamed. I knew that soon after I started doing it three years ago, and it’s still just as true today.

With my high praise of envelope budgeting, you would be inclined to believe that it’s smooth sailing all the way, and that somehow “upgrading” from the standard budget you’ve used for the last 20 years will fix all of your money problems overnight. It might (though not overnight)…but there are a lot of potholes on the way if you’re not careful.

There are a handful of critical mistakes you can make when setting up and running an envelope budget, and they can happen whether you’re a novice or an expert. All of them have happened to me in one form or another in the last three years. If not addressed quickly, they have the ability to collapse your entire system and bring down everything you’ve set up, frustrating you along the way and shattering your faith in what envelopes can do for you.

In this post, I’ll cover eight of these critical mistakes, show you what they are and suggest ways to fix them. Many of them assume that you use an electronic solution to do your envelope budgeting–whether that’s as simple as a spreadsheet or as complex as software like Mvelopes. “Manual” enveloping (the kind with physical envelopes) still suffers from some of these problems, but I’ll mention some key distinctions throughout the various points. Let’s take a look at how you can crash and fail and what to do about it:

Mistake #1: Negative Envelopes

The idea behind envelope budgeting is that you will spend money in an envelope until that money has run dry to $0, and then stop spending. The dangerous thing about electronic tracking is that almost any system will allow you to track a negative envelope balance, which means that you’ve actually spent beyond what’s allotted for that purpose.

Equally dangerous is using envelopes as “zero accounts”–spending into the negative throughout the month and refilling the envelope with spare cash left over from income on the 31st.

Whatever the reason for having a negative balance, they present a slippery slope for your envelope budget. They muddy the true picture of your finances (your positive envelopes can no longer be relied on to truly have their full balance), and they create a constant competition between positive and negative envelopes. Funding envelopes becomes stressful, as negative envelopes constantly demand to be made whole, while the current month’s projections start to fall short.

The only true way to fix this mistake is to treat the floor of an envelope with absolute sanctity, unless a unique circumstance dictates piercing the $0 curtain, and you can confidently say that the envelope will be refilled from equally unique and upcoming circumstances.

Mistake #2: Laggy Tracking

Electronic tracking suffers from another key problem–even if you track expenses the same day you made them, or even while in the store, your system will always be behind your actual act of spending money. I call this phenomenon “lag,” and it can range from a few hours for the most diligent of us to weeks in the worst-case scenarios. (If it’s longer than a few weeks, you’re not really envelope budgeting, are you?)

Lag distorts the picture because your system isn’t able to present the most current information to you, and you’re not able to make accurate decisions as a result. Furthermore, since we are usually eager to track income and will do it almost immediately, the distortion in your system will always be one-way: you have less money than you think! Long story short, you’ll be at a higher risk for overspending.

This phenomenon is amplified if you happen to shop at a lot of big-box stores (Walmart, Target, etc.). Ask me a week from now (or even tomorrow) how my $50 Walmart purchase breaks down in terms of spending categories, and I’ll be hard-pressed to remember. Your system will be made even more inaccurate as you start to guess where the spending belongs.

The easiest fix for this mistake is to track all variable spending (spending where you need to watch envelope balances constantly) the same day you make purchases, and to keep all of your receipts, especially those where you’re bound to forget what you bought. Most software will allow you to enter “pending” transactions, and this is exactly how you can take advantage of your receipts before the transaction actually posts to your bank.

Mistake #3: Moving Money

Envelope budgets are designed to allow you to move money–that’s one of their key features. If you have a want or need in one category, and you decide that other categories are less important, you can appropriate funds in a different way. The problem is when this turns into “borrowing” from other envelopes, and then into downright “stealing.”

Typically, the reason for the move isn’t a choice between one option or another, but our attempt to compensate for a problem area in our budget that seems to be constantly over its funding. Ignoring the problem area leads to problems as other envelopes consistently become under-funded and the real issue isn’t dealt with.

If you find yourself consistently having to move money into a particular envelope, it’s possible that either a. your expectations for spending from that envelope are not realistic and you need to re-visit your spending plan, or b. you are consistently over-spending and can take steps to reduce this.

Mistake #4: Shoot, then Aim

What I mean is–buy something first, and then double-check to make sure you had the money set aside for it. After all, you’re pretty sure you did. Four out of five times, this might work. That fifth time, you’ll send your envelope into the red and start scrambling for a way to fix the hole in your budget.

Even if the money is there, your spending decisions might be affected if you had better knowledge of your envelope balances. For example, it’s January 20th and you are at the grocery store. You buy $60 worth of groceries, since you think you have about $100 left in that envelope. When you get home, you realize you only had $70, and that you need to survive on $10 for the rest of the month or find the money elsewhere.

For anything that’s a variable expense and one you can directly control (gasoline, groceries, entertainment), always check the envelope balance before making the purchase.

Mistake #5: Too Many or Too Few Envelopes

Setting up an envelope budget is a highly personal experience. Many purists will insist on no more than 5-10 envelopes and keep things as simple as humanely possible. Still others will set up as many as 100 envelopes, one for each vendor or expense they take on throughout the month. If you’re curious–we take the middle ground. I have an envelope for every line item of my budget–in other words, so I don’t have to add things up when I create my spending plan–but no more detail than that (I don’t have 5 envelopes for different types of groceries, for example, but each of my insurance products has its own envelope for easy adjustments when the price changes).

Too many envelopes and you risk making the system so complex that you can’t make heads or tails of where you are and how you’re doing. Too few envelopes and it might be equally hard to get your bearings: how much of that “Variable” envelope was really for “Groceries” and how much was for “Gas?”

The answer will be different for everyone, but my general advice is this–make the system as simple and bare-bones as possible, but with enough detail to never question the makeup of individual envelopes or how to calculate their funding targets.

Mistake #6: Treating Your Spending Plan as Holy

Your “spending plan” is essentially a set of targets for each of your envelopes for a set period, typically a month. In an envelope budget, it’s what most closely relates to a traditional budget. For example, my gasoline target may be $150 for the month, I might fund $125 knowing that it’s a light month, and I might spend $120 of that. Targets-funding-spending is the typical workflow for this kind of budget.

However, a lot of people will treat their targets as absolutes, and then wonder why they have envelopes with a lot of excess funding or big negative balances. Funding from your income should ebb and flow with the times, and be directly related to what your upcoming needs are for that particular month. If you have six birthdays this month, but plan to bike to work, it would make sense to use your gas money to fund the Gift envelope.

Evaluate the months ahead as best as you can and fund or de-fund envelopes based on what you see. Don’t be afraid to trust your instincts for now, since you can always move money around later.

Mistake #7: Focusing Only on Monthly Expenses

One of the great features about an envelope budget is that your envelope balances can grow over a period of months or years, just like mini-savings accounts. This is ideal for quarterly, yearly, or otherwise infrequent expenses that are often forgotten in a traditional budget. For example, if your car registration is $120 and due in February, you can fund $10 a month into that envelope from March through February and have enough when payment time comes around.

A frequent mistake of first-time envelope budgeteers is only focusing on monthly expenses. This is convenient because it helps us overlook what stands as an inconvenient truth in contrast: we have less month than we think! (Seems to be a trend in this post). What I mean is–when you take these less frequent expenses into account, the money available from your income every month to fund your monthly expenses is actually much smaller, sometimes considerably so. As a result, we’re forced to make difficult choices about what to cut back every month in order to be able to meet these infrequent expenses without dipping into our emergency fund.

Mistake #8: Front-Loading

Last but not least is front-loading, the practice of not pacing yourself properly when it comes to expenses that occur throughout a month (as opposed to one-time expenses, like a credit card or power bill). As a front-loader, you would fund and/or spend the majority of your target for a particular month in the first few days or weeks of the month, and leave the scraps for the tail end of the month. At times, with categories like entertainment, this might work since you have complete control. With other categories, like groceries, you would be hard-pressed to go without a visit to the grocery store for a few weeks.

One solution to front-loading is to space out the process by funding a percentage of your target every week, biweekly, or some other frequency that works for you. Doing this more accurately reflects the reality of regular expenses. Unless, of course, you like to blow your entertainment budget all at once…

In Closing

Envelope budgeting can be a fantastic tool to turn your financial life around and generate real change in how your spend your money. As long as you’re careful about the eight problem areas I mentioned and address them if you happen to fall into their trap, envelope budgeting will be extremely rewarding and effective in guiding you.

6 thoughts on “8 Critical Mistakes in Envelope Budgeting

  1. I use physical envelopes and cash for my system. I find this works best because you can’t overspend with that system. If you need more money in an envelope you either do without for the rest of the month or you take it from another envelope. This is what works best for me.

    I teach people in my Celebrating Financial Freedom course that a written spending plan and an envelope system are the most important tools you can use to get control of your money. If you don’t use them, you only have a vague idea of how you are spending your money and will almost always end up spending more than you make.

    Keep up the great writing Wojciech.

    “When you help me with money, you help the world prosper.”- J.M. DuMont

    1. Thanks, Jason. We used cash for a while, but found that it was getting difficult, since we’re not always shopping together as a family, and sometimes things have to be picked up on the run.

  2. In the name of not going negative balances since these are “envelopes”

    My reasoning for going negative is to actually show how much I am overspending beyond the $0 floor (while I don’t do this often, and then some would say I shouldn’t even be doing that if I am either curbing or moving money).

    The reports will show how much negative I have spent over a period, so if I have a $100 budget and I go -$15 over 3 times in a year it will show that I’ve gone -$45 in a year.

    The above scenario sounds more like a checking account than an envelope, but I have been taught that if you overspend in one area (or use money from another envelope) then the next month you are supposed to only fill your envelope to the difference of last month, for example: you have a $50 budget but you needed to spend $70 so you grabbed $20 from another envelope, the next month you can only put $30 and put the $20 back into the envelope wher you got it (so in essence, the envelope you borrowed from will have a surplus of $20.

    I wonder if this entry was written based on some of my tech support questions I had 😉 and thank you for bringing to light some great tips here :). I’d also like to point out something about absolute budgeting (holy?) I prefer to use absolute numbers it keeps my budget simple and less complex IMHO. I understand the ebb & flow but that’s what moving money around is for too; and I also use absolutes to create mini savings as pointed out as well (and I have a variety of reasons for this).

    1. Awesome feedback–thanks for sharing how you do things on your end!

      Re: absolutes, I guess I have a sense of guilt about moving money around once the month starts, which is why I try to anticipate ahead of time. Maybe I should just get rid of my guilt! 😉

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