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Setting up a budget is an important part of managing your money. You can figure out how much you earn, record all your major monthly expenses, and then make a plan for how to allocate your after-tax income to ensure those bills are covered—including an emergency fund.

“A budget ensures you’re going to be able to do fun things that you want to do, while working toward more serious financial goals,” says Julie Everett, a certified financial planner with Financial Finesse.

But the hard part might be sticking to the budget you make. And if you regularly overspend, you might not reach those financial goals you’ve set. The envelope budgeting system is one way to track your money each month, and it may help you curb overspending because it limits what you have available.

What is the envelope budgeting method?

The envelope budgeting method is a budgeting system that was popularized by personal finance author Dave Ramsey. The method involves dividing your take-home pay into spending categories (e.g., rent, utilities, etc.), labeling an envelope for each category, and putting the cash you plan to spend into the envelopes. When you need to pay for something within one of those categories, you’ll take money from the appropriate envelope to cover that expense.

“The idea is that once the envelope is empty, you don’t spend any more in that category until it’s time to replenish the next month,” says Amy Lins, vice president of enterprise learning at Money Management International, a nonprofit credit counseling agency.

This budgeting system may help regulate your spending because cash users are more likely to form an emotional connection to their money.

How does it work?

You’ll start by checking how much after-tax money you bring home each month, figuring out where you typically spend money, and allocating the appropriate amount to cover each expense category.

The spending categories are your important expenses that need to be covered each month, and can also include additional “fun” categories. So they include things like groceries, dining out, gasoline, a vacation fund, and personal needs like haircuts and clothing. Because housing costs, utilities, insurance, and debt repayments are typically fixed expenses, they won’t be included in the envelope categories.

If you want a guideline, you can split your money using the “50/30/10” rule. You’d spend 50% of your take-home pay on needs like housing and utilities, 30% on wants like travel and entertainment, and 20% on debt repayment and savings. Let’s say you earn $55,000 a year from a job and bring home $3,400 a month. Your spending would be divided like so:

? $1,700 on fixed needs

? $1,020 on wants and variable expenses

? $680 on debt repayment and savings

In general, expenses like your rent, utilities, and other debts are not included in this budgeting method.

How to create your own budget using this method

Want to set up the envelope budgeting system for yourself? You can either use cash and actual paper envelopes—or you can adopt a digital approach using spreadsheets and apps like Goodbudget.

Here are the steps you can follow.

Step 1: Calculate your take-home pay

Look through your bank statements to figure out how much you take home each month after taxes and payroll deductions. Include all sources of income, such as earnings from a job, side hustle, or investments.

If your income varies every month, then calculate the average by adding up your total earnings for the past year and dividing the amount by 12. In our example above, you bring home $3,400 a month.

Step 2: Create budget categories

When you’re defining your variable expenses, check your most recent credit card or bank statements to get an accurate calculation. Everyone’s categories will be different, but the main ones usually include:

? Groceries

? Gasoline

? Dining out

? Entertainment

? Pet care

? Personal care

? Household necessities

Check whether each expense is necessary. If there are any luxury spending categories, you’ll need to decide which ones you can afford to keep—or cut. “I see a lot of people trim their subscriptions at this point,” Everett says. Going back to our example from before, your total monthly spend is $2,380 each month on fixed needs ($1,700), debt repayment, and savings ($680). That leaves $1,020 left ($3,400 – $2,380) for you to spread across the envelope categories.

Step 3: Assign a budget for each envelope

Now that you’ve determined your take-home pay, envelope categories, and how much you can spend, you’ll decide how much money to allocate to each category. Here’s an example of how you might divide your remaining $1,020:

? Groceries: $400

? Gasoline: $50

? Dining out: $200

? Entertainment: $200

? Pet care: $50

? Personal care: $50

? Household necessities: $70

Step 4: Track your spending

Each pay period, you’ll take out cash—which is $1,020 in our example—and divide it among your envelopes. Write the starting total on the envelope, and list each purchase every time you spend money. Keep a running total of how much cash you have left in each envelope for the month. Then, review your budget regularly.

“If you spend less than budgeted one month, leave that money in the account for the month when you need a little more,” Lins says. “The challenges arise when you get busy, don’t write it down, put it out of sight and out of mind, or don’t develop the habit of doing a budget check-up.”

If you regularly run out of money in an envelope that’s important to you, Everett says, it may be time to reassess what you’ve budgeted for the category. For instance, you might shift money from your “entertainment” envelope and add it to your “dining out” envelope based on your priorities.

What are the pros and cons of the envelope system?

So is this budgeting approach right for you? It all depends on how you spend and manage money—and whether this strategy aligns well with that. Ultimately, understanding the pros and cons of the envelope budgeting system can help you decide whether you want to try this approach.

Pros

The envelope budgeting system can be a good fit for people who want to track their spending and need help staying within their monthly allowance. Here are some other upsides:

? It may help you spend less. People tend to spend less when using cash. In a 2016 Federal Reserve study, the average value of a cash transaction was $22, compared to $112 when paying electronically, such as with a credit card. “Something about having to physically part with the cash makes it harder to spend,” Lins says.

? It reinforces discipline and you’ll know how much you spend. When you put firm limits on your expenses, it may help curb overspending on impulse purchases.

? It provides insight into your spending habits. After a few months, you’ll be able to see how you spend money and identify any problem areas.

Cons

The envelope budgeting system comes with a few drawbacks—but they’re all related to using cash. If you want the benefits and structure of the envelope system but don’t want to carry around cash, consider using a spreadsheet or budgeting app.

? It may be time-consuming. If you decide to use cash and envelopes instead of digital tools, you’ll need to cash your paychecks and divide up the money every pay period. This can get tedious.

? Cash is vulnerable to theft and loss. Homeowners or renters insurance may cover you if your cash is stolen from home, but only up to your policy limits. That’s usually around $200 to $300. Credit cards, debit cards and digital wallets offer more security than cash, and they include $0 liability for unauthorized purchases in most cases.

? You miss out on credit card benefits. Many credit cards come with rewards programs and built-in coverage, such as fraud detection, extended warranties, and purchase protection. You won’t get these benefits if you stick to cash.

The takeaway

The envelope budgeting system is a tangible, cash-based approach that may help you track your spending and limit your purchases. But because cash is vulnerable to theft and lacks the benefits of credit cards, you can also use virtual envelopes or a spreadsheet for a cashless approach to this method. You could also look into other budgeting strategies such as pay-yourself-first or zero-based budget. If you’re still struggling with overspending, you might benefit from talking with a credit counselor at a nonprofit agency, such as the National Foundation for Credit Counseling. They can help you find a budgeting approach that works for you and your financial situation.

EDITORIAL DISCLOSURE: The advice, opinions, or rankings contained in this article are solely those of the Fortune Recommends?editorial team. This content has not been reviewed or endorsed by any of our affiliate partners or other third parties.