Envelope System

I recently stumble upon a really simple but effective budgeting system. I'm sure some of you are already practicing a similar system. It's called the Envelope System. The idea is very simple. You just need to divide your budget into categories and store the cash allocated in their individual envelopes. Once the envelope for a category is empty, you can't spend anymore until the next time you fill it up.

Here's are a few steps highlighted by Dave Ramsey to help start budgeting with the Envelope System.

  1. Budget each paycheck. Budget is a dirty word to most people, but you must budget down to the last dime if you're going to successfully implement the envelope system.
  2. Divide and conquer. Of course, there will be budget items that you cannot include in your envelope system, like bills paid by check or automatic withdraw. However, you can create categories like food, gas, clothing and entertainment.
  3. Fill 'er Up. After you've categorized your cash expenses, fill each envelope with the money allotted for it in your budget. For example, if you allow $100 for clothing, put $100 in cash in your clothing envelope for the month.
  4. When it's gone, it's gone. Once you've spent all the money in a given envelope, you're done spending for that category. If you go on a shopping spree and spend the $100 in your clothing envelope, you can't spend any more on clothes until you budget for that category again. That means no visits to the ATM to withdraw more money!
  5. Don't be tempted. While debit cards can't get you directly into debt, if used carelessly, they can cause you to over-spend. There's something psychological about spending cash that hurts more than swiping a piece of plastic. If spending cash whenever possible can become a habit, you'll be less likely to over-spend or buy on impulse.
  6. Give it time. It will take a few months to perfect your envelope system. Don't give up after a month or two if it's not clicking. You'll get the hang of it and see how beneficial the envelope system is as you dump debt, build wealth, and achieve financial peace! See ... simple!

Credits: Dave Ramsey

Of course, you don't have to really use actual envelopes to implement your budget. You could maintain a spreadsheet, a log or if you are savvy enough, download and run Bucketwise. Start budgeting today to achieve your financial goals!

Trading time for money

We are trained since young that we can trade our time for money. You can give up some of your play time and do some chores around the house for extra pocket money to buy that toy you always wanted. This is reinforced as we enter the workforce. An employee is compensated weekly or monthly for their services while a freelancer charges hourly for her work.

Since there is only 24 hours a day and 7 days a week, the most obvious ways to increase your income is to get a higher paying job or to charge more for your products and services.

Ideally, you wouldn't want your income to be limited by the time you spent on your work. You could hire others to help you grow and expand your business.

However, not everyone have the luxury to get others to work for them. Most of us have to do the bulk of the work ourselves. So how do we make this trade worthwhile?

I believe the answer is passion. With passion, you will be willing to sacrifice your personal time to get things done. With passion, the work you do is art. And without passion, whatever you do can and will be replaced by someone or worse, something else in the future.

If you are passionate in what you do, you wouldn't mind trading as much as your time for it. In fact you will make time for it. And with all that passion, I'm sure the result is something others are willing to pay more for.

Don't just trade time for money, trade it for your passion and you wouldn't need to worry about money then.

Time, money and quality

Everyone knows that time equals money. The more time you spend on doing something, the more it is going to cost you and vice versa. This means that you can manipulate one of these attributes by changing the other. The relationship between time and money isn't always linear. You can for example, spend more time on something to lower its cost. The simplest example would be to hire someone cheaper and have them work on something for a longer period of time compared to hiring an expert to finish it earlier.

This trade-off between speed and cost is something that we all are familiar with. If you are on a budget, you work around that. If you need something fast, you pay more. But things get complicated when you bring quality into the equation.

Unlike time and money, there's no reliable way to quantify quality. To make matters worse, everyone have their own definition of it. In the food industry, some diners might focus solely on the taste while the others take into account the atmosphere and service of the restaurant.

There are some cases where quality is ignored or at least of less importance. When choosing between which store to rent movies from, most of us would either choose the cheaper one or the nearer one to save time. This happens a lot when you are dealing with commodities.

When trying to differentiate your product from the rest of the market, it is best not to focus on making it cheaper or faster. The reason for this is simple. There is a limit on how fast you can do a haircut and how cheap you can charge for a meal.

Quality on the other hand, as stated before, is something more subjective. There are more ways for you to improve the quality of your products and services. You can appeal to the interest of your customers instead of their wallets and watches.

The best thing about focusing on quality is that when you are good enough, your customers will ignore the speed and cost of your product. Look at the line outside a famous restaurant. People are willing to trade their time for a chance to dine there and most of the time the bill isn't exactly cheap.

If you are starting a business or looking to revamp your product line, I think it's a good idea to look at how you can make it more attractive to your customer. Obviously you still need to keep tabs on the cost and time but it will definitely be worth your time to put a little more thoughts into the quality of your products.

Money as motivation

There is no doubt that in some point of your life, you may have been motivated by monetary rewards. Your parents might have offered a nice sum if you pass your exam or you reconsider your resignation after your manager give you a pay raise. But does this always work? Economists set up an experiment to see if offering to pay for blood donation effects our behavior. It turns out that the act of paying for blood donation somehow tainted this act of altruism and less people show up. In this case, monetary incentive actually reduces the performance of the activity.

If monetary incentive don't work all the time, what about monetary punishment. In another experiment, a kindergarten decided to fine parents who come late to pick up their child. Instead of reducing the number of children staying back late, it increases the amount of late parents. They can now be guilt-free by paying the fine.

Money being an extrinsic motivator, seem to back-fire in some cases. They say money can't buy happiness. It seems there is much more that money can't buy.

Getting the order right

In any business, ultimately the aim is to be profitable. You need to figure out how to make money so that you can break even, expand and keep it running. At the beginning, the order of the day is to save money. Why? You need to figure out how to use less and get more. A trader will buy goods at a lower price and sell for profit to consumers. A barber will charge an amount that he will be able to pay his rent and have some left over for food.

Once you figured out how to make money, the next step is how to spend the money to grow the business. Investing in more goods and a bigger warehouse will allow the trader to increase revenue and generate more profit. The barber can hire helpers to increase the amount of haircuts per hour.

Some businesses (e.g. funded companies) seem to have the order reversed. These companies start with a bunch of cash in the bank normally from investors and venture capitalist. They will hire more people than they need and spend on things simply because they can. To make matters worse, most of them don't really know how they will generate income.

After a few years (if lucky), money will start to run out and the management panics. They will frantically attempt to save money by cutting costs, firing employees and scaling down operations. All this happens because they thought, with the money given to them, they can somehow skip the first step and ignore the whole point of doing business, which is to generate wealth not consume it.

This don't only apply in business. You need to get the order right in things you do. As they say, you can't run until you can walk. And most importantly, don't forget the bottom line.