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The Envelope System

My first introduction to savings and investing was watching my parents manage the envelope system. The process was simple; divide your take home pay into three parts: savings, room and board and spending. Each expenditure would be put into separate envelopes, and deposited into a passbook savings account, a checking account, or left in the envelopes to be used for specific expenses. Many families managed their personal finances by using the envelope system. If you tried spending beyond the amount in the envelope, the items just went back at the cash register. If you did overspend, you had to redistribute the cash in the remaining envelopes. It was a zero sum game. Using your savings was discouraged, since that was rainy day money, for college funds and for keeping you out of the poor house when you became old. The system worked well; it was a disciplined approach to savings and spending.

Prior to the past one or two generations, the majority of seniors who lived beyond their working careers found that old age meant living in substandard conditions. Life was not fun for them and living in poverty was miserable. No one wants to go back to those days! That is why social security was started. Currently, the newscasters and lawyers are preaching that the social security system is broken and benefits will not be available to you when itís your time to collect. That is not true! If you paid into social security, you will receive your benefits! At the end of the day, the government controls the treasuryís printing presses, and they will just print more money if necessary. We are the wealthiest country in the world, and the government will honor its obligations! Social Security, however, was only created to be a safety net to prevent seniors from living on the streets and dying of starvation; it was not created to make you wealthy.

While this website discusses many more modern and sophisticated financial planning concepts, the principles behind the envelope system hold true today. High school and college graduates need to establish a pattern of regular savings. Taking a portion of every paycheck and saving it, is the key for financial wellness. People are motivated to save for a variety of reasons: A car, engagement ring, wedding, vacation, house, furniture, college, retirement, whatever. There are a few financial concepts that are critical to understand. First, as mentioned above, itís imperative to establish a program of regular savings when youíre young. Second, time is on your side. For young adults, the time value of money works in your favor. You probably have seen the banking advertisements: if you save $2,000 per year for 50 years, at 8.0%, you can retire with $1.1 million. Third, you also need to understand the differences in investing in a pretax or after-tax mode. There are substantial penalties for withdrawing savings from tax deferred accounts. If you have a short-term need, for instance, to buy an engagement ring, savings in after-tax dollars is preferred. If youíre saving long-term for retirement, then a pretax account is recommended. Some planning is involved. Young adults should start saving now, and get into the habit of paying themselves first. Itís imperative that you develop an additional cash flow that will supplement social security when retiring.  The envelope system was so popular because its underlying financial principles worked. The savings, living, and spending model is still sound financial management. Enjoy the remaining sections of this website, but remember, finance is a life long study.


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