Professional athletes are particularly vulnerable to being in dire straights when they get to their later years. Despite having large salaries compared to most people, they often start receiving their wealth while they are young and inexperienced at handling money. They are also in a particular position to feel the need to “keep up with the Joneses” since they are in the public spotlight and have all kinds of people around them wanting to help them spend their money. Combine this with a relatively short career, going into retirement at the time when most people have just started to enter their maximum earning years, and the millionaire ball player can find himself with no marketable skills and no savings.
So here is some friendly advice for the young athlete who has just signed a contract for $40 M over the next five years. Do things right and you’ll be set for life. Note that much of this same advice would hold for anyone with a large salary, or even a moderate one. Here are some tips:
1. Realize that you will actually bring home a lot less than the amount on your contract. After taxes and paying for expenses, you’ll probably take in around $8 M on a $40 M contract.
2. Because you will probably not have a 401K option, you’ll need to make your own retirement account. The person making $60,000 per year should be putting away about 15% into retirement accounts. They have longer to save (a 40-year career) and less disposable income than the professional athlete, however, so you’ll need to put away at least 25% of your pay.
3. The limits on a traditional IRA are way too low for your income level, so you’ll need to do most of your retirement investing in a taxable account. Still, invest what you can either tax deferred in a traditional IRA or pay taxes upfront and then let your money grow tax-free in a Roth IRA. Sit down with a good accountant and figure out what money you can put into a traditional IRA or a Roth IRA. Invest in these up to the limits. If you decide to carry any of your savings in current income assets (bonds, dividend paying stocks, etc…), put these in your IRA since the interest you earn will then grow tax deferred.
4. For the remainder of you investing, you’ll need to invest in a taxable account, but you can defer a lot of taxes there too by focusing on long-term capital gains instead of short-term gains through rapid trading. The nice thing is that this type of investing requires a lot less time and knowledge. Open up a mutual fund account with a low-cost fund provider like Vanguard and choose low-cost index funds or Exchange Traded Funds (ETFs). Even in a taxable account, your taxes will be relatively low if you keep your money invested in mutual funds with a low churn rate like index funds. Buy diversified index funds like a total market fund or large cap fund coupled with a small cap fund. Go for funds with low fees (less than 0.75%) and no load.
5. Don’t forget about medical costs as well. Sports take a heavy toll on your body, so you may be looking at hip and knee surgeries and other procedures as you enter your forties and fifties. If you can, set up a Health Savings Account (HSA) and fully fund it each year. While you are still playing, most of your medical costs may be borne by the team, allowing your HSA money to be invested and grow for your medical costs later in life. If used for medical expenses, you may well be able to use the money tax-free.
6. Just say no to people offering you “unique investment opportunities.” The most predictable investment is in equities and bonds. Understand that because of your large income you’ll be the target of every scammer and huckster out there. A common tactic of con artists is to appeal to vanity, and with everyone telling you how great you are it is easy to become vain. Also say no when your broker offers funds with big costs to buy in. A limited investment in a buy-write portfolio where stocks are bought and then option contracts written against them is a possible choice, although you’ll generally do better in a pure stock fund. If you really feel like gambling on things like commodities, peer-to-peer lending, or venture capital keep your investment down to maybe 5% of your portfolio.
7. Keep your lifestyle under control. Limit purchases of things that go down in value, like cars and clothing, to no more than 25% of your pay. Instead, put money into things that you can enjoy now and sell later for about the same cost you paid, or more. For example, land, homes, fine wood furniture, and art work (if you have “the eye).
8. Once you do retire, don’t drain your nest egg. Plan on spending 3-5% of your income from your portfolio per year, which allows it to continue to grow to keep up with inflation and avoid reducing the buying power of your money. You might also consider keeping enough money in cash (bank CDs and money market funds) to pay for expenses in years when the market doesn’t perform, and then convert assets to cash in years when the market does well. Realize that once the value of your portfolio starts to decline because you are spending your seed corn, things snowball quickly since your portfolio will be producing less income to make up for the money being withdrawn. Keep track of the inflation adjusted value of your portfolio and cut back on expenses if it starts to decline.
Being a professional athlete provides a unique opportunity to make a lot of money in a short period of time, but once the paychecks stop, you are left with whatever you can earn from your savings. If you are consistently putting money away and buying assets, you’ll be ready when retirement comes.
Contact me at [email protected] or leave a comment.
The SmallIvy Book of Investing, Book 1: Investing to Grow Wealthy
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
