We all know the first immutable rule of personal finance: “spend less than you earn and save the rest“.
Countless books reiterate this very fact over and over again.
But many people find it hard to live by this rule (even while agreeing with the general concept) because they just don’t know how much money they can afford to spend.
Writing down all expenses (either on a piece of paper or using a fancy software tool) helps a bit, but doesn’t answer the main question. If you do like to properly budget, head and download our FREE budget worksheets.
A Weekly Envelope approach offers a very simple yet powerful way to learn how much money a person (it works equally well on families) can spend without harming her financial position, short- and mid-term goals. Here’s how it works. Let’s have a look at a family of John and Jane Doe:
John is a computer programmer and earns $2 000 fortnightly (after tax). Jane is an accountant and brings home $1 300 fortnightly (after tax). Overall, they earn about $7 000 monthly (after tax). They live by the rule that at least 10% of their salary should be saved in an Emergency fund. This leaves them with $6 300 to spend. John created a list of regular expenses and financial obligations:
- Mortgage: $2 800 monthly
- Utilities (including electricity, cell phones, cable TV and internet, gas): $400 monthly
- Car loan: $500 monthly
- Fuel and transportation: around $300 monthly
After deducting all these expenses from their incomes, John and Jane still have $2 300 remaining. Instead of borrowing money from a credit card company (and having to repay the debt afterwards), Jane suggested setting two Financial goals:
- Trip to Hawaii next summer (planned cost: $3 500; monthly savings: $400), and
- Renovating a bathroom within the next 2 years (planned cost: $4500; monthly savings: $300)
They put this money on a reasonably high-interest savings account and will withdraw it when time comes to make a purchase. After all savings and mandatory expenses John and Jane have $1 600 left. If they spend more than this amount during the month, they will put less money into the Emergency fund, or some of their Financial Goals won’t be achieved in time. The easiest way for them to spend less than $1 600 a month is using the Weekly Envelope approach:
Divide the remaining money by 4.3 and put an equivalent amount into a plain envelope (in this case it will be $1 600 divided by 4.3, which gives approximately $370). This $370 is the maximum sum John and Jane can spend on food, entertainment, occasional coffee, clothing, etc. per week.
If at the end of the week there’s some money left in the envelope, John and Jane can either spend it (without having to worry about overspending) and reward themselves for being reasonably frugal, or put it into the next week’s envelope, or put it into the Emergency fund. Similarly, if contents of the current week’s envelope weren’t enough to fund all the weekly purchases, insufficient money will come from an Emergency fund (but obviously, money will have to be put back there).
Benefits of the weekly cash envelope system approach:
Weekly planning allows always staying focused on the spending level without losing the big picture.
Knowing how much you a person/family can spend weekly shows the current spending ability. Impulse purchases will be assessed from the ‘how much money will be left in an envelope‘ position instead of ‘we’ve still got money, right?‘.
It becomes really easy to spot bad financial trends: if three or more weekly envelopes are overdrawn and Emergency fund gets accessed more often than once a week, this should be an early warning that spending habits should be curbed further or soft regular expenses need to be cut off.
For better results weekly envelope can be split (in equal proportions) into daily pieces, and John and Jane won’t need to write down every small expense any more: as long as they stay within their daily limit ($370/7=$52), they can spend money on whatever they want. This saves a lot of time on tracking purchases and occasionally having debates about certain expenses.
Avoiding Five Common Budgeting Mistakes with the Weekly Envelope System
It’s truly amazing to watch people with college degrees and lots of life experience literally be clueless about budgeting (and we’re not talking about such advanced concepts like financial modeling or calculating investment risks!).
Good news is that when we developed the Weekly Envelope online budgeting system, we incorporated means for users to get ready for the unexpected and to follow all Personal Finance Commandments. Let’s have a look at the list of mistakes:
- Not writing down and defining your budget. You won’t believe how conveniently flexible you are when it comes to defining a budget and sticking to it if it all happens in your head. Depending on circumstances, you can think that your weekly budget might be $300 – when in reality it’s half that. Where does the surplus money come from? Well, your cash reserves or (unfortunately, much more often) credit card debt. Weekly Envelope system gives you an exact figure how much you can spend a week in order to spend less than you earn and to save for your goals. If you spend more – you’ll see the impact of excessive spending immediately.
- Non planning for surprise or one-time expenses. From our experience, an average person saves less than 50% of the planned amount because of unexpected expenses (car breakdown, child expenses, social events, etc). The solution? Most “unexpected” expenses are in fact known in advance and are predictable. Day Care center for your kids? Totally expected. Car broke down? Unless it’s a major repair (in which case it might be a good idea to dispose of a car altogether), you could’ve saved up for the repair: after all, you knew that it was just a matter of time, didn’t you? Weekly Envelope system allows you to specify your expenses in advance and save up for special occasions. You will be surprised to see that most your “unexpected” expenses are in fact recurring and can easily be planned.
- Not budgeting for contributions to an emergency fund. This is the most basic rule of personal finance: no matter what – emergency fund is something that you must religiously build up. 20% is the best, 10% is OK, but even 5% is better than nil. Don’t expect to get a salary raise or a fat bonus (especially in the current economic climate): start with things you can actually change. Weekly Envelope system suggests you to save a certain amount of money on a regular basis and informs you about the optimal size of your emergency fund.
- Not changing the budget. If you don’t correct your budget from time to time, you risk forgetting about regular expenses or about changed income structure or about additional financial obligations or … well, you name it. The result? It’s always spending more than you earn and steadily heading toward debt. It’s a good idea to look carefully at your budget every month or so. The best part? Weekly Envelope does it for you and adjusts your budget based on the planned expenses.
- Leaving income for spending without budgeting. Let’s face it: the day you deposit your paycheck is probably the happiest day of the month/fortnight. And it’s so tempting to spend just this little bit on something you’ve always wanted. Just one little purchase… or maybe two. Spending without budgeting gets you in financial troubles faster than anything else. That’s why it’s extremely important to use a reliable method or tool to help you with budgeting. What might this tool be? Well, you guessed correctly: Weekly Envelope personal finance system.
- Don’t leave your life to chance. Taking control over your budget and spending is really easy if instead of stressing yourself with details you look at the big picture first. Good luck!
