By Demetris Constantinou, Contributor
Almost 78% of professional athletes go broke within three years after retirement. Such stellar proportion is a call to action for every professional athlete out there, to educate and surround themselves with competent financial advisors who will create a solid roadmap to financial freedom. Finding the right balance between spending, saving, and investing is a very tricky task and most financial advisors out there will have an opinion about which allocations between the above three comprise the “magic formula”. Truth be told, there’s no such thing as a “magic formula” and the exact percentage of your income that should be allocated between spending, saving, and investing depends on the individual’s risk appetite and goals. There are some basic rules and thresholds which should always be kept in mind when deciding what portion of your income should go into which basket.
To be able to create a good balance between the three, it’s important to understand what each aspect is comprised of and what they’re useful for. Spending refers to the amount of money you spend from each paycheck to cover your daily activities. Nevertheless, not all activities are of equal importance, and this is crucial to understand. Spending is broken down into needs and wants with the former capturing all expenses that are vital to survival and the latter capturing items that add some value to our everyday life, without them being crucial to our day-to-day living. In the simplest of examples, needs include such things as housing, clothing, that every human needs in order to carry on with their lives. A want on the other hand can be a vacation, or a luxury car, which we all would like to have but realistically don’t need, in order to keep functioning. It’s therefore clear that athletes’ spending habits should be skewed towards covering their needs rather than their wants, without saying that athletes should not be enjoying life by pursuing some of their wants.
Saving and investing are similar in the sense that they make your income presently unavailable, but their purpose is very different. When saving your money, you’re essentially putting them aside for future use, without necessarily looking for that money to grow but rather as a means of security for more uncertain times. It’s important that one’s savings cover a few months’ worth of expenses in case athletes find themselves in an emergency; without income. Investing on the other hand, is when an athlete puts their money to work for the purpose of generating future revenue streams that will be able to sustain the athlete after retiring from their short-spanned career.
Investing is crucial to everyone, but it’s even more crucial to athletes whose investments will essentially decide the fate of their future self and ensure they remain financially independent after retirement. Therefore, athletes should allocate a smaller percentage on saving and a larger percentage on investing, given that investing is literally the only way for an athlete to keep income flowing in after their retirement.
Oftentimes we read about the 20-30-50 ratio, where financial advisors recommend that an individual spends 50% of their salary on needs, 30% on wants and 20% towards saving and investing. This ratio is a recipe for disaster when it comes to athletes, not because the financial advisors aren’t correct in their advice, but rather because athletes’ careers are unique, and their revenue streams are highly concentrated within a short period of time. An athlete whose career spans from 10-20 years and is used to certain spending habits, can’t just follow the above ratio because the ratio assumes what is perceived as a conventional career span of about 35-40 years.
Another aspect that makes athletes’ case unique is their high earnings, which allows them to spend a lower percentage of their earnings and still cover more needs and wants than a non-athlete who spends a higher percentage on needs and wants. For example, it’s estimated that the median salary for professional basketball players in the NBA is approximately $4 million each year while the median annual wage in the U.S. is approximately $62,000.
The difference is astonishing and makes the case as to why athletes should be allocating a smaller percentage of their income towards spending and a larger percentage towards investing. Simply put, athletes can leverage their high earnings to ensure a comfortable future through undertaking the right investments and allocating a larger portion of their income towards investing, without having to sacrifice their current spending power and ability.
With all the above in mind, athletes should be aiming closer to a 20-80 ratio where 20% of their salary is allocated towards spending on needs and wants and 80% of their salary is allocated towards saving and investing, with investing capturing the lion’s share of that 80%. On a first glimpse the 20-80 ratio might sound excessive, but once you look at it from a practical perspective, it makes a lot more sense and it might even look aggressive. Let’s take that $4 million yearly salary mentioned above and apply our 20-80 ratio. Net of taxes, that $4 million could be anywhere between $2 – $2.5 million. That leaves the athlete with a spending towards needs and wants of approximately $400,000 per year, which is a ridiculous amount of yearly spending and can be pushed down if the athlete desires to shift more of their earnings towards investing. With the remaining $1.6 million and after setting aside some savings toward a short-term emergency fund, the athlete and their financial advisor should create a diversified portfolio of investments that will aim to generate future earnings for the athlete, even after retirement.
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