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- The cash envelope system is a popular way to budget, since it limits your spending to the money you put in different envelopes for each category of expenses.
- While using cash can definitely be advantageous, especially for sticking to a budget, if you want to earn rewards on your spending you could apply the envelope system to credit cards. This gives you the opportunity to earn cash back or travel rewards for each dollar you spend.
- You just need discipline. With rewards credit cards, you won't simply "run out" of available credit like you would run out of cash. And if you wind up overspending, you could end up paying a ridiculous interest rate on your new debts.
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As the author of a book on budgeting, I have a lot of strong feelings about the best ways to get the job done. My book, Zero Down Your Debt: Reclaim Your Income and Build a Life You'll Love, focuses on the zero-sum budgeting method, which asks you to assign a purpose to every dollar you earn each month to reduce waste.
When you give each dollar you earn a job, you also become more intentional about the way you spend the money you've worked so hard to earn. As a result of using a zero-sum budget, many people find themselves spending less on things that don't matter to them and saving a whole lot more.
While budgeting usually works best when you switch to cash and avoid the perils of using credit cards, you don't absolutely have to steer clear of plastic. In fact, you can use credit cards in conjunction with any type of budget, including one that relies on the cash envelope system.
Keep in mind that we're focusing on the rewards and perks that make these credit cards great options, not things like interest rates and late fees, which can far outweigh the value of any rewards.
When you're working to earn credit card rewards, it's important to practice financial discipline, like paying your balances off in full each month, making payments on time, and not spending more than you can afford to pay back. Basically, treat your credit card like a debit card.
What is the cash envelope system?
The cash envelope system works exactly how it sounds like it would. You take the amount of money you've set aside in discretionary spending categories like groceries, entertainment, gas, clothing, and dining out, and put the money in envelopes designated for each.
For example, let's imagine for a moment you're using a zero-sum budget and plan to spend the following amount in these categories for a specific month:
Groceries: $700
Gasoline: $200
Entertainment: $300
Dining out: $200
Self-care: $200
In this case, you would take the money you needed in cash from the bank for each category at the beginning of the month and place it in a marked envelope. The idea behind the cash envelope system is making sure you stay on track with the amounts you budget in each category, so you would spend the money in each envelope down until it's gone.
Read more: 3 go-to strategies to make budgeting less complicated, less stressful, and easier to stick with
What happens when you run out of grocery money on the 20th of the month? That could mean having to dig deeply into your pantry and freezer instead. Find yourself out of cash for restaurant or entertainment spending on the 25th? That means you don't get to dine out or hit the movies toward the end of the month since you spent too much at the beginning.
Over time, the cash envelope system intends to teach you how to be more intentional with your spending, reduce waste, and leave more money in your bank account to save and invest. It certainly sounds harsh, but you do get used to it.
How to apply the cash envelope system to credit cards
No matter what anyone says, you absolutely can use credit cards and stay on budget. You just need to be considerably more disciplined to stay on track.
To successfully use credit cards alongside a monthly written budget, all you have to do is use your card instead of cash for regular bills and purchases you make in discretionary categories like groceries, dining out, and entertainment. The self-discipline aspect comes into play because, unlike cash in envelopes, a credit card won't simply "run out" unless you hit your credit limit and have your purchases denied.
Let's imagine for a moment your goal is earning rewards. In that case, you may want to consider different credit cards that align well with the categories you spend the most in. For example:
- Groceries: You could consider the Blue Cash Preferred® Card from American Express, which offers 6% back on up to $6,000 spent in US supermarket spending each year (then 1% back) as well as 6% back on select US streaming services.
- Gasoline: The Blue Cash Preferred from American Express also gives you 3% back on US gas station spending.
- Entertainment: Consider the Citi Premier℠ Card, which gives you 2x points on dining and entertainment in addition to 3x points on travel including gas.
- Dining out: Check out the Chase Sapphire Reserve, which gives you 3x points on all dining and travel purchases in addition to 1x point on everything else you buy.
- Self-care: A cash-back credit card like the Chase Freedom Unlimited would work well for all your other purchases since you earn 1.5% back no matter what you buy.
If you're eager to use credit cards in place of cash because you hope to earn rewards on your spending or want a more convenient way to pay, here are some essential tips to making this strategy work:
Take stock of your spending every few days. When you have a set limit you can spend in a variety of categories, the most important step to take is keeping track of how much you have spent in all the categories you're tracking. This should be easy if you're using a credit card since your online account management page will supply details on everything you buy.
Imagine for a moment you signed up for the Chase Freedom to earn 5% back on up to $1,500 in bonus categories each quarter and 1% back on all other purchases. You could use your card to earn cash back, then log in to your Chase account every few days to tally up how much you've spent on food, gas, and miscellaneous purchases.
Keep a running list of spending in each of your discretionary categories. You'll also need to keep a running list of spending in each discretionary category so you'll have an idea of when you're getting close to running out of money each month. If you're using a written budget, you can add a second page where you track your spending throughout the month in every category that's variable.
Make sure to stop before you hit the limit in each category. As you approach your spending limit for dining out, entertainment, or any other category, you need to have the internal discipline to stop! Only spend up to the limits in the categories you've settled on ahead of time, and not a penny more.
Pay your credit card bill on time or early each month. Make sure you pay your credit card bill in full by your due date each month. Not only will this help you avoid credit card late fees, but you'll avoid paying interest on your purchases. This part is crucial if your goal is improving your finances and potentially "getting ahead" by earning rewards on your spending.
Keep in mind that the top rewards credit cards available today charge high interest rates to make up for their rewards programs. For example, the popular Blue Cash Preferred from American Express comes with a variable APR between 14.74% to 25.74%. It can still be a great deal since you earn 6% back on up to $6,000 in US supermarket spending each year (then 1%) and on select US streaming services, 3% back at US gas stations, and 1% back on everything else, but you'll only wind up ahead if you avoid credit card interest like the plague.
Also consider paying your credit card bill multiple times each month. If you want to ensure you stay on track with your budget each month and worry using credit will make it too easy to spend, you can also pay your credit card bill more than once per month - even a few times per week. This strategy can be helpful if you're someone who needs to see their money leave their bank account to feel the full effects of your spending.
The bottom line
You can use credit cards and stick to a monthly budget, although you'll need to be more careful if you choose this route. Credit cards do make it easier to overspend or get carried away, so you have to set yourself up for success ahead of time if you want your plan to work.
Create a comprehensive spending strategy, place realistic limits on your spending, and check in to see how you're doing several times per week. If you can follow those rules, you'll have a much better chance at earning rewards on your spending without racking up debt.
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