In 2003, Netflix began an experiment that seemed crazy to management experts. It instituted a policy of unlimited vacation time for its employees. In the years since, a number of other companies have followed Netflix’s lead, offering employees unlimited paid time off.
The results have run counter to intuition: Employees who are offered unlimited vacation end up taking less time off than those working for companies with traditional vacation policies. Why? A common explanation is that people struggle when they lack clear guidelines. In this case, it appears that in the absence of a defined policy, employees are doing what seems safest. By taking less time off than they could, they’re trying to protect their professional reputations. They want to be seen as hard workers. In contrast, when employees are told that they have, say, 15 days off, they’ll tend to take 15 days off. In short, people do better with structure.
This idea applies in nearly every domain. I recall, for example, taking a family vacation to a destination where both food and lodging were included for one flat rate. The result: Without the usual mealtime structure, I found myself with a stomachache and a desire never to go back.
This same dynamic applies to our personal finances. In other words, limits can be helpful. Counterintuitive as it might seem, if you have a surplus in your budget—or assets that exceed your foreseeable needs—budgeting can be tricky. If the answer to the question “Can I afford this?” is “yes” in virtually every case—or every reasonable case—it’s harder to know how to set boundaries.
For better or worse, financial decision-making is more straightforward for those with limited means. A new iPhone, for example, is either affordable or it’s not. But if you can easily afford a new phone or a new car or maybe even a new home, then it’s harder to know how to establish limits. This might sound like a “good problem to have” but in reality, it applies to many retirees, who have ready access to their life’s savings. It’s useful, then, to examine how others have handled this situation.
Among those who have achieved financial independence, my observation is that people tend to fall into one of three categories:
The first look something like the Vanderbilt family. In the 1890s, the Vanderbilts were the wealthiest family in America. With that fortune, they built the Breakers in Newport, Rhode Island, the largest of the Newport mansions, with 30 bedrooms just for staff. In North Carolina, they constructed the Biltmore Estate which, at nearly 180,000 square feet, is still the largest home in the United States. And, of course, they endowed Vanderbilt University. The unhappy result, however, was that the family’s fortune dwindled in a surprisingly short period of time.
The second group couldn’t be more different from the Vanderbilts. They look something like Ronald Read. A resident of Brattleboro, Vermont, Read spent most of his career as a gas station attendant. But when he died in 2014, he left an estate of nearly $8 million, owing mostly to a habit of frugality. When he drove into town, for example, he would park a few blocks away from his favorite coffee shop to avoid parking meters. When the buttons fell off his jacket, he used a safety pin to hold it closed. His appearance, in fact, was such that a fellow restaurant patron once paid the tab for his meal, believing he was destitute. In short, Read took frugality to an extreme—far beyond what was necessary.
If the first group look something like the Vanderbilts, and the second look like Ronald Read, we might call the third group the Smiths. That’s because they don’t look too different from their neighbors. They’re not obvious overspenders, but they’re not overly frugal either. You might see them in a Mercedes, but they’re just as likely to drive a Honda Accord. You might see them at a country club, but you might also find them enjoying a public golf course. They’re the traditional “millionaires next door.” Sometimes only their accountants know they’re wealthy. In short, families like the Smiths know how to achieve financial balance.
In my career, I’ve interacted with folks in all three of these groups. As you might guess, those in the Smiths’ category are invariably the happiest. And while it might seem like common sense to not spend too much and not spend too little, it can be tricky to achieve this balance. But there are some strategies that can help.
If you’re in your working years, I recommend the “pay yourself first” approach to spending. First, determine how much you’ll need to save to meet your future goals. Then set up a mechanism to save this amount automatically. The easiest way is via payroll deductions into a 401(k) or similar retirement plan. Alternatively, or in addition, you could set up automatic transfers from your checking account to a brokerage account. Or finally, you could ask your human resources department to split your paycheck, so part of it goes into your checking account and part into a separate savings account. However you structure it, the idea is to set aside your required savings first. Then you can enjoy the freedom to spend what is left in whatever ways you wish.
If you’re in retirement, you can follow a similar approach, just in reverse. Whether you follow the 4% rule or another approach to spending, the key is to set up a structured plan for portfolio withdrawals. Suppose you calculated that you can safely withdraw $10,000 per month from your portfolio. You would then set up automated transfers from your brokerage account to your checking account. I recommend scheduling these transfers for the first of every month. You could then freely spend that amount each month.
How would required minimum distributions (RMDs) fit into this framework? For some people, RMDs meet only part of their annual spending requirements, while for others, RMDs exceed their spending needs. That’s why I suggest not distributing your RMDs directly to your checking account. Instead, have your RMDs transferred from your retirement accounts to your taxable brokerage account. That way, you can maintain a steady monthly cash flow in your checking account, making it easier to stay on track.
Once a structure like this is in place, I suggest reviewing it about once a year and adjusting your savings or withdrawal rates accordingly. This, I believe, is the secret to being as happy as the Smiths.