Monday, February 18, 2008

Dave Ramsey Cash Envelope System Report Card

In August of last year, I blogged about a Modified Dave Ramsey Envelope System for managing your finances. I've been using it ever since then and I've had excellent results. In a nutshell, here's the plan.
First, I budgeted for all of my known costs. Mortgage, insurance, utilities (estimated), property taxes, averaged car repair per month, savings, school tuition for the kids and so forth. These were all of the items that were going to remain constant regardless of my monthly activities. It is crucial to note that savings was considered a fixed expense.
The remaining money from my paychecks was put into an envelope (an electronic one in my case) and was used to cover all variable expenses such as food, gas for the cars, clothes and so forth. Anything that wasn't explicitly budgeted came out of my remaining cash with no exceptions. That "no exceptions" rule proved crucial.

The last several months have taught me a great deal. First, I've learned to be even more frugal than before. As I've tracked the money in my "envelope" I've learned that every dollar counts. Here's why.

Say you earn $5000 per month. Does it make a difference if you save $1 on a purchase? Would it make a difference to you if you had brought home $5001 or $4999 instead? You'd hardly know the difference.

All of these are not created equal.

After taking out all of your fixed costs, say you're left with $400 each month out of your $5000. If you've got a big mortgage or major credit cards to pay off, that can happen. That $1 is heck of a lot more important now, isn't it? That concept of marginal utility is what makes Dave Ramsey's system work. A dollar is worth more to a poor person than it is to Bill Gates.

By removing your fixed costs and dealing only with what's left, you find yourself feeling much poorer than before. The math hasn't changed, but your perception of the world certainly has. That change in perception brings with it a change in spending habits.

The second thing I learned was why that "no exceptions" rule was important. When expensive times of the year come around, like Christmas or birthdays, your first impulse is to take these once-a-year purchases off budget. It's not like you're going to be buying gifts for your kids all the time. After all, that money you're saving can be stopped for one month to take care of the things the kids or spouse want, right?

Wrong.

Once you start taking things off budget, discipline breaks down and you can begin excusing all kinds of things. Remember, Man is not a rational animal, he is a rationalizing animal. As painful as it is, those gifts have to come out of your puny cash envelope. This one bit me in December. I had saved some money through the previous few months and thought I had enough to carry me through Christmas. Here's where my modifications to the Dave Ramsey system hurt me. Instead of using a real, live cash envelope, I used an Excel spreadsheet to track that budget item.

I got busy doing other things and stopped tracking my finances until after the Holidays. It was a classic blunder leading to a classic forehead-smacking moment when I sat down and tallied up the spending. Ouch! I was sorely tempted to give myself a one-time indulgence and write it off, but I decided not to. That was just too much of a slippery slope. Had I been using the real cash envelope, I would have known I was heading towards the rocks. Instead, I ended up in the red in my Excel spreadsheet and have had to really tighten the belt lately to drag myself back out.

That leads to the third lesson of the experiment. If you're not going to use a real envelope with cash in it for this budget, then you need to keep on top of it all the time. If you don't, the situation can get away from you.

The last lesson I learned was that none of this was painful at all. Quite to the contrary, I've thoroughly enjoyed it. I have financial peace and I've had a good time finding bargains. Thanks to things like Craig's List, I'm still able to go out and buy some pretty nice stuff. Thanks to my Dave Ramsey system, I'm much more motivated to do it. I recently bought a 36" TV for $40 from Craig's List. Way cool! It took a little patience to wait for one to show up, but it finally did and I've now got a good TV in my living room for hundreds of dollars less than I would have paid retail.

Had I not used the Dave Ramsey Envelope System, I would not have put the same value on my money and probably would have ended up with a new TV and a whole lot of financial stress. I'll take the old one and financial peace any day of the week.

11 comments:

B-Daddy said...

You've been linked.

Anonymous said...

The concept of marginal utility doesn't imply that a dollar is worth less to a multibillionaire than to a poor person. Even a presumption of diminishing marginal utility is far too weak an assumption to produce that conclusion.

For that conclusion, one has to assume that utility is very strongly cardinal — having the property that it means something to apply arithmetic to utilities across persons — and that if two people had the same wealth then they'd enjoy approximately the same level of utility.

There are excellent reasons not to accept these further assumptions. One observable implication would be that people could fully order their preferences, but experiment indicates that they cannot. And the distinctive implications of strong cardinality are wholly unobservable, so the assumptions are in gross violation of Ockham's Razor.

What diminishing marginal utility says about Bill Gates's dollars is no more than that the next dollar will be put to a use that had lower priority for him than the use to which he put the previous dollar.

Anonymous said...

I like your post. I have not gone through the Financial Peace University, but I have begun listening to Dave Ramsey occasionally.

I just heard of the envelope system today, and realized that I already do something similar for expected big purchases. I budgeted out how many presents I have to buy throughout the year, and created a "sub account" in my ING Bank savings account. Then I save a specific amount each paycheck throughout the year. When birthdays or Christmas occur, I feel very little impact because I have distributed it throughout the year.

Anonymous said...

Try these out for a more fashionable cash envelope system.

http://laceyandtyler.blogspot.com/2009/02/fashion-cash-clutches.html

Anonymous said...

There is something very powerful about handing over cash at the store! I have been using the cash only system for a few years and what a difference it makes!
But instead of using envelopes - use the designer cash envelopes -
very inexpensive and really cool designer fabrics! check it out!
www.crunchycute.com

Anonymous said...

Hi All,
I found some super cute coupon organizers @ http://www.austinartisan.etsy.com. She has 100's of styles, they are all handmade and she even made me a custom monogram for my daughter.
She runs specials all the time so go visit her store. I am so excited about my order with her.

She is having a Mother's Day special right now. 2 for $21.00, can't beat that!

Julie said...

Hilarious! Hi there to my fellow competitors! I also make "cash clutches"
I began making them 1 1/2 years ago and I have been loving them.
Check out all my different styles at www.mylilbudgetbook.etsy.com
and check out my blog at www.mylilbudgetbook.blogspot.com

Happy Budgeting for ALL!

Anonymous said...

I am considering giving the envelope system a try and am trying to get a handle on how to impliment with the hub. But my understanding about the difference with clutches and coupon files vs the envelope system is that "the system" includes record keeping functionality. Correct?

K T Cat said...

Anon, I never used the exact system Dave suggested. Instead, I budgeted for the things that were constant - mortgage, $ set aside for car repair, insurance, utilities, etc. and then used an envelope for the things that were variable - food, entertainment, etc. You definitely need to keep records for it to work if you don't go straight cash for everything.

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Niki said...

Just a note - I tend to lose cash; no, not spend, physically lose it. As a result, the envelope system is irresponsible for me. I use excel to track larger static expenses and an envelope app on my iPhone to track smaller ones. I currently have no interest collecting debt other than my student loans, and as of September, my student loans will be all I have.