Last month an economics professor wrote an article in Slate magazine trashing the envelope method on economic principles. The key argument went like this: because money is fungible, strictly separating your budget into categories is a bad idea. For one, prices go up and down and we should account for these price differences by adjusting accordingly. In other words, artificial constraints are bad for you.
Well, as it turns out, traditional economics does not have a theory to explain why artificial budgets exist at all. Yet, we all know that a good budget is a great thing. It keeps us honest, accountable, and performing. And even if we recognize that budgets aren’t always perfect – they can sometimes create unnecessary constraints – they do serve their purpose whether in your household, in your business or in the US Government (ok, well maybe not the US government).
"the answer is what every person who has ever spent too much money, had too much to eat, or left something to do tomorrow already knows: we are not perfect"
And there are indeed other perspectives outside traditional economics that explain budgets. Even within economics itself, the growing field of behavioral economics can easily explain why the envelope budget works so well. And the answer is what every person who has ever spent too much money, had too much to eat, or left something to do tomorrow already knows: we are not perfect.
We all know the most popular day to start a diet is tomorrow. And saving money is no different. People often buy things in the beginning of their pay period, thinking that they will save more later. But then when later comes, people spend again. This is the chief reason why credit card debt is so high. One way to deal with our tendency to procrastinate is to pre-commit ourselves to a hard budget. When you use the envelope method you force yourself to stick to that budget for that period.
We hate losing (even more than we like winning)
If you are walking down the street and find a $100 bill, you will be very happy. But for most people that happiness will be a lot less intense than the feeling of looking at your pocket and realizing you just lost $100 bucks. Humans are wired to fear loss. When you use the envelope budget, whether with cash, or with an app, you actually see your money dwindling from your envelope as you spend it. That sensation of loss, however small, does make spending money more painful. And as a result, you are more likely to fight other spending impulses and save more than if you were using another method.
We are lazy
Most people stick to default choices because they are easy. When you set up a budget you create all sorts of default choices regarding how much you usually save each month, how much you usually spend in groceries, etc. If you have a savings envelope for $300 bucks a month, you will probably do the same next month. This tendency to fall back to the usual is also why almost every budget method recommends you set an amount to savings to “pay yourself first” by default (or even automatically). This way, you not only pre-commit to that savings, but also set a regular amount which would on average be a lot more than if you would freely adjust your budget from scratch each time.