News came this week that Allen Iverson is broke.Allen Iverson, you will recall, used to be a star basketball player. He made $21 million one year playing for the Detroit Pistons. And he made more than $150 million in his career (a lot more, presumably, when one factors in endorsements and other ancillary income).
But now Iverson is broke.
And so is Lenny Dykstra, who made a boatload of money playing for the Mets and Phillies.
(Dykstra’s now worse than broke—he’s in serious legal trouble. But his legal problems appear to be related to his financial problems.)
And so are a whole bunch of other athletes who made inconceivable amounts of money in their pro sports careers and then blew it all. And so are dozens of lottery winners. And so are many successful entrepreneurs who sold their first companies for tens of millions of dollars and then went bust.
Going broke sucks, especially when you should have been set for life.
So it’s time to give these rich athletes and other folks who suddenly come into piles of money some financial advice.
They won’t want to hear it.
But they need to.
So here goes…
FINANCIAL ADVICE FOR ATHLETES AND OTHERS WITH SHORT, HIGH-PAYING CAREERS AND MASSIVE PAY-DAYS
First, if your money comes from your salary, recognise that your lucrative career will not last forever. In fact, it likely won’t last more than a decade, if that. So please understand that you will not be making this kind of money for the rest of your life
Second, do not confuse your huge salary with your take-home pay. Before you see a dime of that money, you have to deduct taxes, agents’ fees, accounting and legal fees, and other professional fees. And the amount left for you to spend after deducting those fees, though huge, will be smaller than you think.Third, understand that the money you take home in your short, high-paying career or big pay-day will likely have to last you forever (unless you are highly confident you can do something else that pays a lot later). Piles of money throw off a lot less cash per year than you may think they do. So your sustainable annual income after you retire or sell your company will be a lot less than you may think.
Fourth, recognise that the amount of money you are making is actually relatively easy to blow. All it takes is living the high life for a while, supporting your entourage, and making a few bad investments (and you’ll probably make a lot of them).
Fifth, commit to automatically saving a big percentage of your take-home pay every month, perhaps even 50 per cent or 75 per cent. Why so much? Because unlike, say, a doctor or accountant, you’re only going to be making the big money for a few years.
Sixth get realistic about the future investment returns that you are likely to make with your savings. How big are those returns going to be? Even if you invest well, they will be a lot lower than you think. If you invest badly, meanwhile, they may be horrible.
Seventh, taking into account all of the above, put yourself on a monthly and yearly spending allowance. Do not exceed it.
Let’s put some numbers on this.
Let’s assume that you are going to make $100 million in your ~10 year sports career, or, say, $50 million from selling your company.
You should never, ever assume that you’re going to make that much, of course, because only a tiny fraction of professional athletes and entrepreneurs will ever be that successful.
You should never, ever assume that you’re going to get another contract after your first one, in fact. Because you might not end up being as good as you think you will be. Or you might get hurt. Or arrested. Or busted using performance-enhancing drugs. Or any other number of things that will make that first contract your last (or even void it).
So, really, you should save just about all of that first contract or company-sale.
But let’s assume that that first contract guarantees you $100 million and that it’s such an iron-clad contract that there is a very high likelihood that you’ll make every dime of it, even if you never hit a home run or throw a touchdown pass or do whatever else it is your team thinks you’re going to do.
How much money should you spend?
Well, for starters, let’s figure out what your take-home pay will be.
If you earn $10 million for 10 years, your take-home pay will be about $4 million a year.
How do we get there?
Let’s run the numbers.
First, pay your agent—the guy who got you that contract. Sports agents generally make 3%-5% per cent or your salary and more of any endorsement deals. So your agent will take about $300,000-$500,000 of your $10 million per year.*Second, pay your lawyers, accountants, financial advisors, and other professional services providers. Unless you want to handle all that stuff yourself, these folks will soak up more cash. As long as you can credibly argue that it’s a cost of doing business, it will be pre-tax. But it will still probably add up to a couple per cent of your salary. So that’s another, say, $200,000-300,000 a year.
Third, pay your taxes. You’re in the highest bracket, and you’re paying Social Security, Medicare, et al. So just figure that your tax rate will be about 50 per cent. So, of the ~$9 million a year you have left after paying your agent, you’ll keep about $4.5 million.
So, right there, just after taxes, agent fees, and other professional fees, you can see that your take-home pay is considerably lower than most of your friends will think.
So your take-home pay is $4.5 million a year. How much should you save?
You should save at least $2 million a year and probably $3 million.
You’re only going to be earning this money for a decade. At the end of the decade, you will be in your early 30s. You need the money you make now to last you for 50+ years after you stop playing. And you need to support yourself and your family after you stop playing, which means you’ll need to spend some of it every year. So you’re going to need a LOT of money when you retire.
How much money will you need when you retire?
Well, it depends how much you want to spend each year.
As long as you invest your money intelligently, you should be able to sustainably spend up to 2–3 per cent of it per year and still have it maintain its purchasing power. If you spend any more than that, the odds increase that you will someday go broke. And the point of this advice is to help you avoid going broke.You will note that 2–3 per cent of your money is not a lot.
If you have $10 million saved at the end of your career, a 2–3 per cent allowance will allow you to spend $200,000–$300,000 per year. If you have $20 million saved, you’ll be able to spend $400,000–$600,000.
Given that you probably plan to spend a lot more than that in your big-earning years when you think you’re making $10 million a year, you’ll probably want to aim for a big sustainable allowance after you stop playing—say, $600,000–$900,000 a year. (Otherwise the “austerity” shock will really crimp your lifestyle.)
That means you’ll need at least $30 million in the bank.
If you want to have $30 million in the bank after 10 years of taking home $4 million a year, you need to save ~$3 million a year.
If you invest that $3 million per year intelligently, you’ll likely have more than $30 million by the time you retire, because it will grow a bit along the way.
But it won’t grow that much.
Especially after you deduct:
- advisory fees (1–3 per cent per year),
- taxes (20–50 per cent of gains), and
- inflation (2–4 per cent per year).
Unless you are really smart about managing your money (most people aren’t), these costs and fees will usually eat a lot more than half of your return—and that’s if you even have a return. Inflation, meanwhile, will demolish the value of your money. As Warren Buffett recently observed, the value of the dollar has fallen by 86 per cent since he started working. If you live a long life, it will probably fall by that much in your lifetime, too.
Basically, if your savings are invested intelligently, you should expect your money to to grow at about 2–3 per cent per year after costs, taxes, and inflation. And that’s in average decades. In bad decades like the one we just had, the growth will be much less. That’s why you can only spend 2–3 per cent of your money per year if you want to maintain its purchasing power.
Yes, if you make some excellent investments (or get lucky), you can do better than that. But if you try to make excellent investments, you’ll also probably make some terrible ones. So you need to factor the cost of those in, too.And because you know that you need your money to last, you shouldn’t take too much risk with your investments.
In other words, you should be well-diversified, with your savings spread among stocks, bonds, and productive real-estate (productive = earning a return, not many personal mansions).
So you shouldn’t assume that your investments will return more than, say, 7 per cent per year, gross (before fees, taxes, and inflation). And even that may be pushing it.
So, bottom line, if you get a contract that guarantees you $10 million a year for 10 years, your annual spending allowance should be no more than $1 million per year.
In the context of the money you think you’re making, $1 million won’t sound like a lot.
But it actually is a lot.
You can have a lot of fun with $1 million a year.
So, enjoy it!
Just be sure to save your $30 million and invest those savings intelligently.
More on how to do that in future posts …
SEE ALSO: 13 Lottery Winners Who Lost It All
* I initially used a 10%-15% estimate of agents’ fees. After reading the comments of a couple of sharp readers below, I’ve reduced it to 3%-5%.
Business Insider Emails & Alerts
Site highlights each day to your inbox.