The principle in question here is that “money is fungible.” In reality, all dollars are the same. There is no such thing as a gas dollar, a grocery dollar, a “fun” dollar. The Ramseys of the world argue you should just apportion them into the envelopes depending on what you think you might spend. But doing it this way is not actually the best way to dole out your money; you are not optimizing. Your money is just not working as hard as it should.
The system works great, as long as nothing ever changes. But the minute that some price changes, you’re in trouble. Here’s an extreme example. Imagine you drive to work, and your “gas money” envelope contains enough money to get you to work for the month, and maybe a little cushion. But then gas gets more expensive. You may first react by switching to a worse grade—say, from premium to regular (research shows many people do this). But if gas prices go up even more you simply will run out of money in the gas envelope. And then you won’t be able to get to work. Strictly following the envelope system here would be much, much worse than “cheating”: It’s certainly bad for your household budget if you miss work.
This presumes that the envelope system is static and the allocation of money in the envelopes never changes as prices change. In other words that you do your budget once and never alter it. It is clear that the strong form of this argument is actually a straw man -- would anybody let themselves be evicted because their rent went up but they could not bear to alter the values on the envelopes? In general, this system will fail int he face of massive price and income volatility, but then nothing works well when you cannot plan for future income and expenses.
In my experience, the actual reason for the envelope system is one of two cases:
1. It reduces the complexity of managing a detailed household budget
2. You are really so poor that you have no ability to reallocate money
In my youth, I knew a lot of poor people (less so now, which is not necessarily a change for the better) and, in fact, was very poor for a time. When your budget is tight enough it may really be the case that you cannot overspend on gas for the car without being unable to pay rent and/or eat and/or pay the electric bill. People at this level of poverty do not necessarily have credit cards..
One of the features of being middle class is having flexibility. Consider the plane ticket example that Dr. Oster presents: that makes total sense if you could (in theory) allow a credit card to increase. But if the cost of the item would bring your bank account below zero and you don't have credit (or it has ruinous terms, like a payday loan or a 30% credit card) then you simply can't spend the money at all.
In practice this lack of flexibility can be very tough. There are a lot of items that, bought in bulk, are cheap. But bulk items are hard to transport on the bus (especially if it is crowded) and cost more (and you often cannot borrow against the future). There are a surprising number of costs to being very poor (as opposed to being very frugal).
So, yes, it is possible for the envelope system to be too inflexible and that is not ideal. But it is very, very useful when you have $110 after rent and utilities to make the rest of the month work.
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