“Broke”- It Would Probably Happen to You, Too

Monday, February 4th, 2013 by Cass Chappell, CFP®

Summary: Athletes earn their money very quickly. Their careers don’t last very long. They are very young when they retire and have unusually long “distribution phases”. Since they usually don’t earn much after their playing days are over, they typically are in financial ruin very soon after retirement. Having all of the money at once clouds the reality of what that sum of money can support for an extended period of time. Obvious statement – they should live on far, far less than they do.

The ESPN 30 for 30 documentary, aptly titled “Broke”, is full of tales of excess, bad advice, and bad investments. It is a sobering documentary that explores the fact that so many of our retired athletes are flat broke. Many within just a couple years of retiring. I have always been surprised by most people’s reaction to these types of stories.

It seems to me that, universally, people are appalled or shocked when they hear of a big-time athlete or entertainer going broke. “What a dummy! How could someone who earned (insert really big number here) be broke?”

But, why are we all sure that this wouldn’t happen to us?

I contend that the vast majority of people, thrown into the same situation, would experience the same fate.

It seems that Americans have a natural tendency to live RIGHT AT their income level. I don’t need to quote national savings rates or other statistics to validate this assertion. It’s just my gut instinct. Income is relative too. I think many people who make $50,000 (approximately the median income in this country) are just as disgusted when they read about a foreclosure on a $600,000 home that was owned by someone making $200k. “What a dummy! If I had all that extra money, I know I wouldn’t have gone broke!”

Athletes and entertainers do earn a lot of money. They also earn it quickly. More money than almost everyone will earn in their lifetime comes in just 3 or 4 years for an average NFL player. It’s this lump sum payment that causes such a problem.

See. The rest of us have a safeguard in place. Like bumpers in a bowling alley. It stops us from getting in too deep. We only get paid periodically and we earn our lifetime income over our lifetime. Not in just a few years.

Let’s say that someone earned 100k per year and was 35 years old. This person could expect to earn about 4 million bucks between now and 65. I just assumed a few raises and a promotion or two.

That 4 million will provide for her for the next 30 years while she is working AND (hopefully) some of that money was socked away to provide for retirement. The goal should be a big enough nest egg accumulated to supplement her social security.

She is never going to get a lot more than 100k (before taxes) in a single year to spend during her working years. This is a very powerful safeguard.

Imagine giving this same employee 4 million bucks upfront and then taxing it so she is left with 2.5 million. That’s it. You will not earn another dollar for the rest of your life. You are 35 years old. What would you do?

The “Sustainable Withdrawal Ratio” is just a little over 4.5% of a lump sum of money. This also has only been tested for 30 year time frames. The woman above, realistically, has a 60 year time frame! This would mean that she should spend less than 4.5% of her nest egg for it to last that long.

Having all that money staring her in the face, I think she would buy a nicer house, a nicer car. Maybe a more lavish vacation. She is in the beginning stages of financial ruin.

So what should Mr. Star Running Back (SRB) do? He is 24. He was drafted high in the first round and received a four-year contract worth $15 million. He will have to pay taxes and an agent. After taxes this should amount to around $7.5 million bucks.

Mr. SRB will, in all likelihood, not sign another contract after this one. It would be extremely fortunate if he did, but the numbers say no. He will be 28 and retired. Hopefully he earned his degree and can pick up a second career. But let’s be conservative and help Mr. SRB see some realistic, and LIKELY, scenarios.

He could live for 60 years, or more. We know that his spending should be south of the 4.5% Sustainable Withdrawal Ratio that has only been tested for a 30 year time frame. So let’s use 4% of $7.5 million.

Mr. SRB should develop spending habits that are commensurate with a $300,000 per year income. If he did this, he would have a legitimate chance of living that way for the rest of his life. He would be able to increase that income by inflation every year. He might even have a nice sum of money left at the end to leave to his heirs. He could, in effect, be pretty close to a “1 percenter” for the rest of his life.

As I type this next sentence, I have a smirk on my face. I see why so many people are shocked and appalled. BUT. Mr. SRB is going to have a very tough time living on such a “small” income.

If he commits to anything much more than a 750K house and two nice cars (not the kind that turn heads) , he is either on the road to financial ruin or he BETTER sign a second contract or have a solid job lined up for when his playing days are over.

It would take a lot of courage and wisdom to avoid the temptation to “keep up with the Joneses”.

The best observation in “Broke” was from an athlete quoting a mentor: “You can live like a king for a few years. OR you can live like a prince forever.” Unfortunately, many athletes seem to go the king route.

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