Budget for future expenses with the digital envelope system

The most powerful budgeting tool I’ve found is really the simplest one: A spreadsheet to not only track my expenses, but to project them into the future.

I used to keep my money in two accounts: checking and savings. I had a vague notion of how much was going to be spent every month, but random expenses showed up every couple of months. So I kept a huge “just in case” buffer in my checking account for a major car repair, an unexpected bill, or some other cost I hadn’t anticipated. Then one month I was hit with three of these and my balance dipped much lower than I was comfortable with. That’s when I decided it was time for a spreadsheet.

The value of having a spreadsheet

If you haven’t used a spreadsheet before, don’t worry. The spreadsheet I use to budget and track my income and expenses is extremely easy to set up, and you could master it with a basic YouTube tutorial. My spreadsheet allows me not only better track my monthly spending, but also look years ahead at my expected expenses and budget for things like my car insurance every six months or my daughter’s annual daycare expenses. We save several hundred dollars on each by paying both of these large bills in one big chunk at the beginning of the term rather than as monthly installments. It also allows me to put medium-term savings into a high-yield online savings account to earn a few extra dollars in interest than if I left it in my local bank.

My system isn’t a strict budget. It’s more of a general projection of where my money is going to go. As my real expenses come in, I replace the projections with actual data and verify that my accounts have as much as they should have at month’s end.

What my budget spreadsheet looks like

It’s not the prettiest design in the world, but I created a custom spreadsheet to track my past and future expenses up to three years in the future. Building your own sheet makes you much more in tune with your finances.

The image above shows my spreadsheet with some sample data. I have the following spending categories set up:

• College costs for my son (tuition and books, paid twice a year)
• Transfers to my wife (we keep our money separate and just transfer to each other)
• Credit card payment (I project a realistic average each month)
• Life insurance (term policy paid monthly)
• IRA contribution ($458 monthly to max it out)
• Other investments
• Miscellaneous expenses (ATM withdrawals, large expenses paid out of savings)
• To savings (more on this in a minute)

Next, I have a row for my regular paycheck income and another for miscellaneous income, such as checks for birthdays or cash from selling something. Then I add up all the expenses and subtract them from the income to see what my overall difference is.

The “to savings” section  is money that I transfer to a CapitalOne 360 account, where I have eight different savings account “envelopes” set up, each one named for its purpose. With the envelope budgeting method, after each paycheck you put money for each of your expenses or savings goals into a different envelope. That’s what I’m doing here, just digitally, and it allows me to get 0.75% interest on my savings vs. 0.05% in my regular bank account.

The eight envelopes I have for savings right now are:

• Daycare
• Vacations
• Car insurance
• College tuition (I save in the high-yield, then move it to my regular account to cover the credit card bill when tuition is due, so I also get cash back from my credit card)
• Christmas
• Investment property (my wife and I are considering buying a rental and are saving for the down payment here)
• 529 account (I’ll write more on this in the future, but we get a state tax break for contributing to a 529, and we use this money to pay for my son’s housing rather than tuition for tax purposes)
• Emergency fund

Looking at this spreadsheet allows me to quickly see what my expenses have been, about what they’re going to be, how much I have saved toward various goals, and when I should transfer money to cover planned expenses. The color codes up top are green for income and red for expenses; below they are green for saving and red for spending.

What I find most useful about this approach, though, is that I can earmark money for future goals long before I actually have access to it. That helps build in my mind that the extra money has a purpose already, so when I get it I’m not tempted to find another (less intelligent) use for it. This is great if you know you’re going to get a bonus or pay off a debt and you want to allocate that money to a higher purpose. It’s a psychological trick to help keep your priorities in order.

Less crystal ball and more Magic 8-Ball

Of course a lot can change between making your initial projection and when your actual expenses roll around. But I’ve found this method makes it easy to adjust on the fly. I’m not predicting the future; I’m simply looking for a pretty good guess at what’s likely to happen if everything stays status quo.

I project my income and expenses out about three years into the future. That’s long enough to make a realistic prediction of how my expenses may shift based on my mid-term plans, but not so long as to be pure fantasy. For instance, we’ll make our final daycare lump sum payment in August. That frees up $200 a month I was allocating to that envelope. I’m going to shift that money to increase savings for college tuition, which is due in October. After that, it will start filling the Christmas envelope. Once I make the last tuition payment in February, it’s time to start saving for my wife’s next car, which we’ll buy with cash. I know where that $200 is going for the next three years, so it won’t have a chance to settle into my checking account and fuel lifestyle inflation.

I usually put my variable expenses on my credit card, which I pay off every month, and the monthly amount I project for that is the average of the previous year’s spending. I track those expenses in a separate tab, but you could just as easily build out a much more robust spreadsheet with categories for groceries, restaurants, home improvement, etc. and try to more finely budget/project those. For now, this works for me. And that’s really the point. The best personal finance tricks are just that — personal.

Knowledge is power

Building your own spreadsheet really makes you examine where your money comes from and where it’s going for the next several years. Using this method allows you to:

• Ensure you’ll have enough money for rare or infrequent expenses.
• See the effect your current spending has far into the future.
• Adjust your monthly budget to better prepare for the future.
• Determine quickly if you can afford to add other expenses.

Instead of thinking about your budget as an isolated monthly benchmark that you either stuck to or you didn’t, you now see how each month’s spending affects your outlook for years to come. That’s a powerful motivator.