Allen Iverson was once the most famous basketball player in the NBA. According to one report, he earned a salary of $154 million during his playing days. Now he may be broke. The same report indicated a judge in Georgia ordered him to pay $860,000 to a jeweler. He didn't have the cash, so the Court ordered his bank accounts frozen and his earnings garnished.
Iverson's sad plight is not uncommon among professional athletes. Another report noted that a representative of the NBA Players' Association indicated in 2008 that 60 percent of retired NBA players are broke five years after they stop receiving their paychecks. At the time, the average player' annual salary was $5.36 million.
So far, efforts by the players associations to protect athletes from greedy managers, promoters, financial consultants, dumb investments, and their own profligate spending habits have been a dismal failure.
It's time for drastic action. Here's a simple plan to save athletes from the fate of their peers. You can adopt it as well.
Forced savings. Require the teams to withhold taxes and deposit 25 percent of the after-tax amount of the total salary of every athlete into a designated trust account. The trustee would be a "directed trustee", typically a bank that provides fiduciary services relating solely to the administration of the plan assets, but does not engage in investment advisory services. Those services are provided by an independent investment adviser. Directed trustees are fully insured and bonded. Some of the leading directed trustees are Advisory Trust of Delaware, Santa Fe Trust, Reliance Trust, and Wealth Advisors Trust Company of South Dakota.
Designated investment advisers and fees. Prepare a standard trust agreement for use with all athletes, unless there is a compelling reason to deviate from it. It would require the directed trustee to retain independent investment advisers who meet the following criteria:
--Their primary focus would be on an appropriate asset allocation of the portfolio.
--The adviser would agree to limit investments solely to low management fee stock and bond index funds, passively managed funds, or exchange traded-funds.
--The portfolio would be globally diversified, with the goal of capturing market returns.
--Advisory fees would be established by a simple formula, depending on the amount of assets invested, with a cap of 0.5 percent. With the ability to direct significant assets to the adviser, the negotiated fee could be much lower.
Limit withdrawals. Absent extraordinary circumstances, no withdrawals could be made from trust assets until after retirement, at the earliest. Players would be encouraged to defer withdrawals for as long as possible. The trustee would be required to prepare a Monte Carlo analysis which simulates thousands of portfolio outcomes based on long term risk and return data. This analysis presents statistical probabilities of portfolio survival at various ages of retirement. Withdrawals from the trust will be governed by the results of this analysis.
Here's what a Monte Carlo analysis would have shown for Allen Iverson: From total earnings of $154 million, $38.5 million (pre-tax) would have been withheld during his playing days. After taxes, $25.1 million would be left in the trust. While this money would typically appreciate over his playing life, let's assume it remained the same. This assumption should offset fees relating to trust administration and advisory fees.
Iverson is currently 37 years old. Let's assume he will never make any money until he dies in 58 years at age 95, so he will need to start withdrawals immediately. I used long term risk and return data from a portfolio consisting of 60 percent stocks and 40 percent bonds, invested as required by the trust documents.
The Monte Carlo analysis showed that Iverson could withdraw $700,000 a year (pre-tax), adjusted annually by 4 percent to account for inflation. The inflation adjustment is meaningful. At age 57, his withdrawal would be more than $1.5 million in today's dollars. There would be almost no statistical likelihood of depleting these assets before his death. In fact, it is statistically far more likely that his ending wealth would be many millions of dollars. Obviously this report is based on many assumptions which can significantly alter the outcomes. While it can't cover all the changes that occur throughout a lifetime, it provides a very helpful guideline.
If the players associations in professional sports want to do more than pay lip service to the financial plight of their members, all they have to do is adopt these recommendations. But you don't have to be an athlete to benefit from these recommendations. You can run your own Monte Carlo report here.
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book, The Smartest Money Book You'll Ever Read, was published on December 27, 2011.
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