At Squirrel and Nest we are huge advocates for people paying for every purchase possible with cash, especially when people are first learning about their finances. The key to any stable spending plan is to two-fold: 1) know where your money goes, and 2) spend less than you make.
Notice we didn’t say, “Make a budget and stick to it!” All realistic spending plans need to be flexible because we’re people, and if there’s one thing we know about being people, it’s that life can and will be unpredictable where we’re concerned. That said, operating within your income is absolutely necessary to your financial wellbeing. That’s where cash envelopes come into play.
For many people, cash in hand is like butterflies: there one minute, gone the next, and who knows where it went. This often leads people to feel they are irresponsible or “bad” with cash, but what’s really going on here is a problem rooted in a lack of clear supports. Cash envelopes provide the support and framework needed to begin understanding where cash goes and why. Perhaps one of the simplest money tools you can use, a cash envelope is money you place in an envelope and track when you spend. When you’re getting started, aim for a modest goal: stick to a cash budget in one spending category for a week to increase your chances of success and give yourself room to learn. The idea of sticking to a budget for one week is reasonable, and this limited timeframe provides a good training ground to develop new spending habits and financial skills.
The Cash Envelope Method
Start with a single item from your spending plan that you’re familiar with and use consistently. For most people, this spending category is the food budget. Once you select your category, your goal is to stick to a cash envelope for that category for one week.
If, for example, you have a four-week month and a budget of up to $1000, you’d have up to $250 available for food each week. To begin, withdraw $250 from your account (never, ever, EVER take a cash advance out on your credit card -- if you do you will immediately begin to pay fees and a high interest rate, all of which costs you more money unnecessarily).
Take an envelope and write Week One: Food Budget on the front.
Write the total cash you have available for the week. Stick the cash inside, and viola! You’re set to go.
When you go grocery shopping for the week, you’ll be taking your cash envelope with you to pay for every food purchase you make. Be sure to keep your envelope in a safe place that’s accessible to you.
While you shop, try to keep a running total of the food you’re buying. This can be done via your brain, if you’re so inclined, by paper, or by using a calculator (most phones come with this feature now, but there’s nothing wrong with a Dollar Store calculator, either). In doing this, you’re developing a better understanding of what you’re about to spend, which connects you to the cash in your envelope and by extension your greater spending plan.
After you’ve collected your groceries, go to the register and ask the cashier if the store offers a cash discount (yes, do this; it’s particularly effective small, non-chain grocery stores -- the worst they can say is no and you’ll survive that). If they say yes, woo hoo! You’ve saved some money! (Seriously, though, ask for a cash discount for everything you buy every time you use cash).
Take your receipt. Take your receipt. Check that you received the correct change (yes, do this -- we're all people and people make mistakes and that’s okay).
Write the total you spent with the date on the front of the envelope and tuck the receipt inside your envelope.
Calculate your new running total for your budget.
When this works
By the end of the week you should be able to account for every bit of cash you spent down to the last penny. Hopefully you’ll even have a bit of money leftover. If you do have a bit of cash remaining, tuck it away for now, in case you need it to cover other parts of the month. At the end of the month, if that money is still around, toss it into an emergency fund, add it onto a debt payment, or put it into a savings account -- then pat yourself on the back because you rocked this! Continue to use cash envelopes through the end of the month. If it works well for you, consider how you can apply the cash envelopes to other spending categories.
Why does this work?
A few studies like “Researching the Pain of Paying” argue that we spend less when we use cash because we have a better understanding of what we’re giving away and having that psychological connection means parting with cash hurts. Other studies, like the much-cited study by Dunn & Bradstreet found that people who use cash spend less than when they spend with credit cards -- the findings stated that people spend 12-18% more when they use credit cards.
That could very well be a big part of the story, but it’s not all of it. So much of what we do, especially where money is concerned, comes back to habit. When you use the cash envelope technique, you’re actively trying to learn new spending patterns and money associations. Not only do you have to calculate your approximate total before going to the register, once there you have to confirm that you do, in fact, have enough cash for your purchase. With credit cards it’s so easy to plug in and go
-- and with many of the credit card machines, once you plug in the total disappears from the screen.
Even after you’re done with the immediate transaction, when you use cash envelopes you’re not done with your learning and engagement. You take the receipt, write down the total, and then calculate your remaining cash for the week. Every time you do this, you’re reinforcing a connection to your money and developing a better understanding of where your money is going. Knowing where your money is going and what you’re doing with it is a critical step in living debt free and financially independent.
What if this doesn’t work?
If you try this and don’t immediately meet with success, don’t despair! Learning new habits is never easy. It takes time, consistency, practice, and kindness. Be patient. When you make mistakes -- and we all do, even the most budget-conscious of us -- don't give up. Look at what happened, acknowledge what you did, make a plan for how you’d handle it differently in the future, and then keep going. Stick to it. It’s likely that you’ll discover you need to change habits that are deeply ingrained, or re-evaluate the choices you’ve been making with your money. For a lot of us, it’s all too easy to get caught up in the idea of having a particular lifestyle when we cannot, in fact, afford what it means.
Just remember: you’re reading this for a reason. You want to learn how to handle your money; you’re smart; you’re engaged; and you’re moving in the direction of financial freedom. You can do this.
Squirrel and Nest offers one-on-one and small group financial counseling services that aim to give individuals the knowledge and independence they need to get their financial lives in great shape.