Monday, August 06, 2007

A Modified Dave Ramsey Cash Envelope System

As many of you know, I'm a huge fan of Dave Ramsey's Financial Peace concepts. Starting this August, I'm implementing a modified version of his cash envelope budgeting scheme. In Dave's scheme, you make a budget for every item and put the appropriate amount of cash in an envelope for that item. For example, if you've budgeted $400 per month for food, then you have an envelope marked "Food" with $400 cash in it at the beginning of the month. That's all you get and you'd better make it last. I like the concept, but it doesn't work perfectly for me. Because my travel schedule is so variable, I don't have the requisite consistency to make such a plan work. Instead, what I've done is modify it slightly.

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. This is key to the purpose of Dave's plan. This left me with an amount, let's call it $350, to cover all of the variable costs for the month. That would be food, gas, clothing, school field trips for the kids, etc.

The $350 is just the starting point. Out of that comes my expenses while on the road. Into that goes my per diem for my trips and any other odds and ends I might receive. For example, my little dribs and drabs of cash from Pay Per Post go into this. This is the only envelope I use and it covers everything variable.

Mathematically, the key feature of Dave's plan is that it eliminates uncertainty from your finances. That is, I know that I will save X dollars per month because I have forced all of my variable costs into a single budget line. Without such a plan, savings gets blown away month after month because something always comes up that seems like a good idea. After all, I'm tired when I get home from travel and I don't really feel like cooking. Would it be so bad to go and get a fish burrito? And I could really use a new pair of shoes. Where does that money come from? Without such a system, it comes from a big blob of cash in your checking account. With the system, it comes from the envelope whose cash content is known. It doesn't take a rocket scientist to see if you can or cannot afford those shoes this month.

The other thing this does is force you into making decisions on the margin which is where they should be. That is, will I be happier with a pair of shoes or going out to dinner four times? Will my marginal increase in pleasure be greater if I choose the shoes or the sushi? The envelope only has so much money in it and spending it on one thing means it can't be spent on something else.

I've only been using it for a few days and already it's changed the way I look at my financial decisions. I've always been pretty disciplined in my spending, but this codifies it and forces every financial decision to be made based on sound principles. On the downside, it adds stress to my life as I have not received my per diem payment from my last trip and the envelope is getting pretty empty. However, since I know that several fairly large payments will show up this week, I know that my stress is only temporary. In any case, the stress should always have been there since all I've done is to make myself painfully aware of the exact mathematics of the situation. I haven't changed reality, I've just clarified my perception of it.

If you use a system like this or a different one you like better, leave a description or a link in the comments and I will post it here as an update.

For more tips on living frugally, visit this week's Festival of Frugality.

Update: After trying this for 7 months, I've posted my report card post and lessons learned.


Kelly the little black dog said...

I've thought of something like this, but I've never actually tried it.

I seem to recall someone I know saving for their first house in the late 80's, following something similar.

K T Cat said...

Kelly, get yourself a copy of Dave's Financial Peace. I picked mine up at a used bookstore for almost nothing. It's a great book.

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muebles en galapagar said...

It can't work in actual fact, that's what I think.