Weekly Envelope approach to personal financial planning
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.
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 Envelope 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.
Tags: ability, envelope, financial plan, money, planning, spending, trend
