Personal Finance Strategies for a One-Time Windfall or Large Sum of MoneySubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on June 22nd, 2018
By Devone McLeod, CFP®
You may have heard of a Sports Illustrated study reporting that 60 percent of NBA players – who earn more in one year than most people can save in a lifetime – either go broke or struggle financially after five years of retirement from the game.
You would expect a few financial horror stories here and there – a dishonest advisor, a business deal gone bad, etc. – but SIXTY PERCENT?
It’s not just young athletes who have a tendency to overspend when money comes in too quickly or too easily: Seventy percent of rich families lose their wealth by the second generation.
This article will show a better financial path, not only for pro athletes but for anyone lucky enough to receive a sizable one-time windfall or large payout early in life.
The Danger of Overlooking Real Risks
Once you’ve built enough wealth to sustain financial independence without earning additional income, financial planning is all about addressing risks. The NBA Draft was held last night, so let’s use a hypothetical late first-round NBA Draft pick “Bobby Smith” to illustrate what I mean.
Bobby is headed to a California team and is guaranteed $1,920,000 per year over four years. The first NBA contract for a player who may never receive a second contract should be treated similarly to a one-time windfall from an inheritance, lottery winnings, or even the one-time sale of a business early in life.
How would he run out of money?
After taxes and agent fees, approximately $3.8 million of his $7.68 million contract will actually reach his bank account. That’s still a lot of money, but being young and feeling invincible, he believes his next contract will pay him eight figures annually over four or five years.
As a result, he may feel comfortable spending what his peers spend. The average NBA player, according to Money, spends $510,000 per year. This means Bobby will save 23% of his pre-tax annual income, a far higher percentage than young professionals in other industries save.
At this savings level, however, he’s still exceeding his “speed limit” – the amount he can safely spend each year without putting his lifestyle at risk.
Even if he cuts his spending in half after his playing days are over, without that second contract, he’ll run out of money – or at least the money earned during his brief NBA career.
Below is a screenshot from our myMoneyGuide software illustrating this:
Each line on the graph below represents a different economic scenario; we test for 1,000 scenarios to review the full spectrum of possibilities. In each scenario, he runs out of money due to his spending habits during his four years in the NBA.
When someone takes money for granted, whether it’s due to family wealth or a young athlete feeling invincible, over-spending is a major risk.
One reason family wealth often runs out within a few generations is that children who grow accustomed to a luxurious lifestyle may not fully understand the scarcity of money.
How Much Money Can He Afford to Spend?
To make his first contract truly last a lifetime, Bobby could set his annual budget to a more reasonable $250,000 per year. That’s less than many of his teammates will be spending, but still the high life compared with others his age.
Or, he could simply plan to cut his spending by 80% if his NBA career doesn’t extend beyond his rookie contract. I view this plan as less than optimal because that’s a really hard cut to make.
Here’s how it changes his outlook:
All of those green lines in the chart represent a scenario in which he gets to sustain his lifestyle.
Whether it’s an NBA contract or a lump sum from another source, keeping your spending in check is the foundation for maintaining financial independence.
Creating a Financial Plan to Address Remaining Risks
If I were advising “Bobby Smith” or any of last night’s late first round draft picks, my advice would be to treat their first contract very similarly to the way we would advise a young man or woman who received a generous inheritance: you’ve been given the chance of a lifetime, so let’s protect what you’ve got by addressing risks.
Here’s what he could do:
- Have a financial plan that includes a spending budget
- Determine how much money he’ll need to sustain the lifestyle he wants for the rest of his life
- Always pay himself first, saving enough each year to reach his financial goal by the end of his first contract
- If he wants to help family, he should do so after he's paid himself first
- Invest conservatively in publicly traded securities, aiming for 5% to 7% returns
- Insure income-generating assets, including his body and health
- Delay any risky business plans until he has enough “play money” he can afford to lose
- Remember that his real friends will be happy for his success without asking for handouts
Conserving and Protecting Financial Independence
If you or someone you know could benefit from professional advice on how to address risks in order to secure financial freedom, please do not hesitate to contact Reby Advisors.