This post was originally published on our previous blog website on November 1, 2017 and has since not been revised and/or updated.
I am a big sports fan and being a finance guy, I am always fascinated by athletes’ contracts. By no means do I think they are undeserving. If people are willing to pay admission to watch you do your job, then you are damn good at what you do and deserve every penny the market is willing to pay you. You could argue that some athletes are overpaid for the production they deliver for their teams, but don’t hate the player – question the team owner for coughing up the dough.
For anybody that follows professional basketball, you probably heard about Russell Westbrook’s record-breaking contract extension that was signed in late September. On the birthday of his former teammate and fellow NBA superstar, Kevin Durant, Russell Westbrook of the Oklahoma City Thunder signed a five-year, $205 million contract extension. That is in addition to the $28.5 million he will be earning for this current season. Let’s ignore this season’s salary for the time being.
Two Hundred and Five Million Dollars
Most Powerball winners don’t win that much. And if they do, it is paid over a 20 year span (you don’t get the full amount if you take it in a lump sum). Russ is getting all of that over five years. That is $41 million per year. Or $500,000 per game during the regular season. Can you imagine someone paying you $500,000 every time you played a single game of basketball? Just thinking about it makes me smile.
Since this is a personal finance blog, let’s break down the numbers and see what Mr. Westbrook could potentially do with this money.
How Far Can $205 Million Go?
We will ignore endorsement money that he earns (which is significant) and pretend his only source of income is his NBA paycheck. We will also pretend that he didn’t earn any money before this and his career will be over after the end of this five-year deal. I think most people would be content earning $205 million over the course of their career, so we will work with that figure.
At that income level almost half of his paycheck will go to taxes. That brings his take-home pay down to $20.5 million, using round numbers and approximate math. Let’s say he give $500,000 per year to charity, leaving him with $20 million to live on and/or invest for his future.
Russell seems like a smart guy so we will assume he knows it would be dumb to blow all that money at once and end up broke like many former professional athletes do. He still is one of the highest paid professional athletes though, so we will assume he lives a good lifestyle. Let’s pretend he budgets his living expenses to be $1,000,000 per year, leaving him with $19 million to invest each year for the next five years.
Over the next five years, if he invests $19 million per year into a diversified portfolio of mutual funds, that would be a total of $95 million invested. He knows he has a lot of money, so he doesn’t need to take on too much investment risk. If his portfolio grows by an average of 5% per year and he continues his $1 million/year spending budget, adjusted for inflation at 3%/year, he would have over $114 million when he retires. Not a bad amount to have in the bank when you are in your early 30’s (he will be 34 years old when this contract is up).
Thanks to inflation, by the time he is 40, he will need to spend $1.35 million per year to sustain the same lifestyle that $1 million gets him today. The items on the value menu at McDonald’s keep getting more expensive. The man’s got to eat. He will also have $144 million in his investment portfolio at that time. He can probably afford to add fries and a drink to his burger.
When he is 60, the portfolio balance will be $321 million and he will be spending over $200,000/month to sustain his lifestyle. If he lives to age 88, he will be a billionaire. He better start finding some charities he wants to bequeath some of his wealth to. Maybe he will build a library, or a new basketball arena at his alma mater, UCLA.
Let’s Increase the Spending
In reality, he will probably spend more than $1 million per year. And why not? He can afford to. How much could he afford to spend without running out of money?
We will continue to assume his investment portfolio grows by 5% per year and inflation stays constant at 3% per year. Anybody want to take a guess? If he invests $17.5 million per year for the next five years and spends $2.5 million per year for the rest of his life (adjusted for inflation), he would run out of money at age 95. His largest portfolio balance would be about $166 million when he is in his mid-60’s. From there, he will be spending more than the portfolio is growing by and the balance will begin to dwindle.
If he gets accustomed to spending more than $2.5 million per year, there is a good chance he will run into money issues later in life.
So, Russ, if you are reading this, don’t spend more than $2.5 million per year. You can thank me later.
But what if he is a little more aggressive with his investments and shoots for more growth potential? After all, with that much money he can probably afford to take a little more risk. If he increases his exposure to equities, maybe instead of a 5% annualized average return, he can achieve a 7.5% average return over time. If he invests $16,000,000 over the next five years and lives on $4 million per year adjusted for inflation for the rest of his life, earning 7.5%/year, the money would likely last until his early 90’s.
Alright, Russ, if you are going to live on more than $2.5 million/year, you will need to invest more aggressively to give your portfolio a chance of being able to sustain your lifestyle over time. But cap your spending at $4 million per year. You can thank me later.
Some Takeaways
In the $1 million per year spending scenario, Westbrook will be living far below his means and money will probably never be an issue. He could afford to live comfortably, support family, donate to charities, and not stress about money. His biggest concern will be from an estate planning perspective and what will happen to all of that money when he passes away!
The more money he spends, the less likely he will be able to afford his lifestyle in the future when his basketball playing days are long behind him.
Another big takeaway is the more you save and invest, the less risk you need to take with your investments. You can afford to take a more conservative approach to investing, which is preferable for many people. If you spend more, you will need your investments to grow more significantly to support your lifestyle over time. This means you will need to take on more risk with your investments to give them a chance to grow enough to support your needs.
When you are planning for retirement, if it appears you will fall short of your goal, there are several things you can do to increase the probability of reaching that goal.
- You can work longer (health permitting) or work more to earn more income (if possible).
- You can spend less and invest more while you are working.
- You can live on less in retirement.
- Or you can increase the aggressiveness of your investment portfolio to give it more growth potential.
The last option only works to a certain extent. If you are investing in an overly conservative portfolio for your goals and time horizon, then increasing portfolio risk can be a possible adjustment to get you on track. If you are already taking on a fair amount of risk, then there likely isn’t much more you can do here. You will have to look at the first three bullet points to get your plan on track.
I would also caution you if you are thinking bullet point number three is a viable option. If you are used to living a certain lifestyle for your entire working career, it will take a near miraculous effort to scale back and reduce your living expenses when you get to retirement. Many people are forced to cut out expenses in retirement because the well runs dry. It can be very demoralizing and embarrassing.
Regardless of whether you are a school teacher making $40,000/year or an NBA superstar making $40 million/year, it is important to plan your finances accordingly. Know what you can spend today, how much you need to invest for tomorrow, and how to allocate your investments to reach your goals.
Disclosures:
Any examples are hypothetical and for illustrative purposes only. Any investment has risks, including the total loss of principal. Consult with your financial advisor to determine a savings and investment plan for your particular financial circumstances.
