The Envelope System - How to Set it Up

This is a three-part series on the financial tool called the envelope system. In the series I have covered what the envelope system is (part 1, here), how to set one up (this post) and, as a real world example, how I have leverage it in my finances (tomorrow).

Below are the general instructions on setting up a manual and electronicly automated envelope savings system.

General Envelope System Prework:

1. Itemize out all your expenses and savings goals for the year. Be sure to calculate regular expenses like car, rent/mortgage and savings goals as well as irregular expenses like once a year property taxes or semiannual car insurance payments.
   
2. Group all the expenses by category.
   
3. Total the annual amount per category.
   
4. Divide the annual amount that you calculated in step 3 by the number of times you get paid per year. This gives you the contribution amount per envelope per pay-period.
   
5. Sanity Check - Make sure the toal contribution per pay-period is less than or equal to the amount of your take-home. If your contributions are more than your take home pay then you know it is time to adjust your savings goals
   

Manual Envelope System Setup
If you are going to do the manual envelope system I would reccommend getting a fireproof box with a lock to hedge against potential fire or burglary.

1. Get some envelopes.
   
2. Write the name of the categories and the amount you plan on contributing on the envelopes.
3. Every pay-period allocate the proper amount into each envelope.
   
4. Monitor and adjust the amounts as you notice differences in your origional calulations and projections.

Electronic Envelope System Setup
I use ING Direct for the automated electronic version of the envelope system.

1. Open a bank account or several. I like having a seperate online accounts that acts as my "virtual envelope".
2. Direct your employer to deposit your check into a holding account.
   
3. Setup an automatic savings plan or automatic transfers to your different virtual envelopes in the designated amounts that we figured out in the prework above.
   
4. Monitor and adjust the amounts as you notice differences in your origional calulations and projections.

That's it! In the words of famous inventor and infomercial host, Ron Popeil, all you have to do is set it and forget it! Ok. Actually don't set it and forget it, but monitor your progress. Don't get discouraged if you aren't making gains super fast. You made the plan, thought it through, now give it time to work!

Tomorrow I will discuss how I have leveraged the power of this system in my own personal finances.