The Wall Street Journal published an interesting article recently regarding the sad financial future awaiting many NFL players.  The article cites a study that analyzed the financial data of more than 2,000 players who were drafted by the NFL from 1996 to 2003.  These players were followed until 2013 to see how their financial health would hold up after retirement.  After 12 years in retirement, more than 15 percent of the players who were followed had declared bankruptcy.  Were these players predominantly those who were drafted and only played a year or two at the lower end of the pay scale?  Apparently not.  Earning a higher income or having a longer playing career did not seem to offer much protection against bankruptcy after a player’s NFL career came to an end.

There is no shortage of statistics when it comes to professional sports, and this is as true for salary information as it is for measures of athletic performance.  The Spotrac website offers a wealth of information on current NFL salaries, including a ranked list of the top 1,000 cash salaries in the league.  In 2016, the top earning player was Drew Brees at $31.25 million.  Nearly 100 players earned over $10 million in cash compensation while 880 earned over $1 million. In 2015, the average NFL salary was $2.1 million while the median salary was $860,000.  The rookie minimum wage was $435,000.  1,696 players were employed by NFL teams.

So these guys are making very, very good money at a very young age and it is safe to assume that the vast majority of these players in their early 20s have never seen this kind of money before.  Here’s the problem:  The average length of an NFL career is only 3.3 years, although this figure varies widely based on the position played and the ranking of the player in the draft.  But how many new guys entering the NFL believe that their career will be just a few years?  Probably very few.  They see the money coming in, feel invincible, and believe that the good times will keep rolling indefinitely, or at least until their 30s, which for someone who is 22 seems a lifetime away.  How do you think they are going to choose to spend their newfound wealth?

Beware of the Ratcheting Lifestyle

The financial problems facing new NFL players are different than what most of us face in life, but only because the abrupt change of income experienced by players is far more noticeable than what the rest of us experience.  An NFL player goes from earning little or nothing to earning at least $435,000 per year as a rookie, and subsequently will earn much more if he performs well and remains healthy.  The rest of us earn little or nothing while in high school or college and then experience a significant jump in pay, but obviously nowhere near a half million dollars.  Then, if  all goes well, pay will rise gradually over time as we get more experience and take on more responsibility.

In some ways, the NFL player should have an easier time avoiding the temptation to ratchet his lifestyle significantly because it is obvious that playing careers do not last very long.  If it is very unlikely that a player will be in the NFL past age 30, it is obvious that plans need to be put in place to address that, whether it involves a second career or accumulating enough assets to be financially independent.  The rest of us do not have these obvious prompts to consider our level of spending.  Most people immediately ratchet up their lifestyle after graduating from college and save very little.  Then, annual raises are automatically spent as they are earned.

The Hedonic Treadmill

But wait a minute … what is wrong with increasing spending as one’s income increases?  Isn’t one of the major motivations for going out and getting an education (or making the NFL) the idea that we can then life a more comfortable lifestyle?  This is certainly true for most people and studies have shown that people do gain a significant amount of happiness as they increase consumption to meet basic needs.  Many people will experience happiness beyond that point as well, although obviously the degree to which happiness is correlated with increased consumption will vary based on personality and other factors.

However, one aspect of human nature that seems universal is that at some point, the degree of happiness one gets from spending an additional dollar declines.  Furthermore, human beings have a tendency to return to a stable level of happiness after a major life change.  This is referred to in psychology as the hedonic treadmill effect.  (As an aside, one of my favorite books on psychology, Thinking Fast and Slow, by Daniel Kahneman touches on this subject along with many others.)

The temptation facing the NFL player is probably quite extreme.  Going from earning no money to earning, perhaps, half a million dollars in his first year, it would be difficult to avoid peer pressure to go out and buy a luxury car, a new home, better clothing, and to spend lavishly on entertainment for real and fake friends, as well as to try to help out family members.  Getting into the NFL is a very high publicity event.  Everyone the player has known for his whole life will probably become a new “friend” instantly and given that the player is now “rich”, he might seek to impress his new “friends” with money.

A new college graduate who is entering a more prosaic field, such as accounting, faces some of the same psychological impulses, although at a less extreme level.  With a new job paying $50,000 per year, she might move into a recently built apartment in the city, spend more on personal services, go out to eat and drink with friends, purchase new clothes, and make a down payment on a more modest car.  But she is facing similar temptations to spend up to her newly found income limit.  And in some ways, her problem is worse than the NFL player’s because there is no real upper bound on how long an accountant can work.  You can have a 50 year career in accounting, assuming that you want to have one and jobs are available.  So why not go out with friends and drink $15 cocktails?

So, We Should Save Everything? 

The point isn’t to suggest that people who have suddenly experienced an increase in income should take no actions whatsoever to fund a better lifestyle.  It would be ridiculous to suggest that an NFL player, or our accountant for that matter, should be subjected to poverty and save almost everything.  That isn’t the point.  The goal is to be mindful regarding spending and to understand the trade-offs that inherently exist.  Also, it is important to know yourself and how your personality will deal with the diminishing returns from additional spending.  You don’t want to be a hamster on the hedonic treadmill.

The question of how quickly to increase spending when income suddenly increases depends on many factors, some of which include:

• How long will the increase in income last?
• What is the starting level of spending that you are accustomed to?
• How much do you enjoy the work involved in earning the income?
• How likely is it that employment in your chosen field will continue to exist in the future?
• How important is financial independence to you, irrespective of whether you like your work?

For the NFL player, it is pretty obvious that the income will not last for very long no matter how much the player enjoys playing football.  So a good question to ask is whether the player wants to work in some other field after his playing career is over.  The stereotype of the academically challenged jock is just that, a stereotype, and there is no reason why a former NFL player in his late 20s or 30s cannot have a full career in some other field.  Even if so, financial independence after the NFL, or at least some assured minimum level of income for life, seems to be a worthy goal.

Financial Independence After the NFL

Assume that a player is drafted and earns a first year salary of $500,000 followed by an increase to $750,000 in the second year, and $1 million in the third and fourth year.  On the final game of the fourth season, the player suffers a career ending injury and has to retire.  In aggregate, the player will have earned $3.25 million in gross pay over four years.  For purposes of this brief analysis, assume that the player lives in Texas and does not incur state income taxes (although this is unlikely since many states will tax players on games played in-state).

H&R Block provides a free tax estimator that I will use for this example.  Assuming that the player is single with no dependents and takes the standard deduction, he will earn the following on an after tax basis:

• Year 1:  $500,000 gross income – $154,375 tax = $345,625 net income.
• Year 2:  $750,000 gross income – $255,625 tax = $494,375 net income.
• Year 3 and 4:  $1 million gross income – $356,875 tax = $643,125 net income.

We can see that the $3.25 million in gross pay has already shrunk to a little over $2.1 million after paying federal income taxes.  How much should the player spend and save each year?

Here, the situation becomes even more interesting.  First of all, the player does not know that he will be forced to retire after four years.  He only finds out at the end of the fourth season when he suffers a career ending injury.  Therefore, from the perspective of the player at the start of his career, it is not apparent that his lifetime earnings from the NFL will be around $2.1 million in terms of cash in his pocket.

But for the sake of argument, assume that the player knows that the average NFL career is under four years and intelligently assumes that he won’t beat the average by that much.  Also, assume that he can predict his salary increases after his first year.  So, now we have a 21 year old newly minted NFL player with almost $350,000 of income in year one.  How much should be spent and saved?

To answer this question, let’s assume that the player wants to ensure that he has at least some minimum level of financial security after retirement from the NFL, for life.  Median household income in the United States in 2015 was slightly over $56,000.  Let’s say that we define financial security as the ability to withdraw $56,000 from a portfolio on an inflation adjusted basis in perpetuity.  Using the 3 percent withdrawal rule that I prefer, the portfolio needs to be 33 times the withdrawal level, or 33 x $56,000 = $1.85 million.

$1.85 million!  On an after tax basis, our NFL player is only collecting $2.1 million in cash over his four year playing career!  Ignoring investment returns, this means that the player only really has about $250,000 to spend over his four year career in the NFL, or approximately $62,500 per year, on average.  In reality, the situation is probably a little bit better because he will be earning investment returns on funds saved during the course of his playing years, so let’s say that he can spend about $70,000 per year while playing.  If he spends $70,000 per year during his playing career, it seems likely that he will have a large enough investment portfolio to be financially secure for life, if we define financial security as the ability to withdraw, on an inflation adjusted basis, the median U.S. household income in perpetuity.

Is This Realistic? 

The honest answer is probably not, at  least for the average NFL player.  There are very, very few men in their early 20s who are going to have the self discipline to earn enormous salaries in the NFL but spend only $70,000 per year on an after tax basis.

Yet is clearly possible.

Plenty of people get by on far less than that.  Furthermore, $70,000 is well above the typical gross income in the NFL player’s age cohort.  In other words, his friends from high school and college who are not playing in the NFL but working in other jobs are likely to earn far less.  So, we are not talking about any major deprivation here, only exercising a very unusual level of self restraint.

What does seem to make a great deal of sense is for an NFL player to be very, very conservative in his early years while stockpiling an initial sum that can guarantee financial independence for life.  After that point, if he is still playing, it is very likely that he will be earning a much higher salary.  Staying in the NFL for a decade or longer is not just a matter of staying healthy.  You have to perform.  Veteran players in their late 20s and 30s are going to earn several million dollars per year.  Younger players should attempt to defer big ticket items until later in their career once basic financial freedom has been assured.

But What’s the Alternative?

Taking a more common path, the player will probably spend the vast majority of the $350,000 in cash received during the first year.  Spending on a luxury car, better clothing, vacations, and entertainment can easily soak up a couple hundred thousand dollars, and perhaps he will also make a down payment on a house.  With an increase in income in the second year, spending will ratchet accordingly and probably include even more entertainment, perhaps a second car, and much else.  After reaching a salary of $1 million in year three, all sorts of additional spending options come into play, perhaps even including a small share of a private plane.  After all, many veteran players are earning $10 million per year, so why not?

The tragic consequences of a career ending injury at the end of year four becomes glaringly obvious for someone who has adopted that kind of lifestyle.  Not only are his playing days over, with the associated loss of prestige and popularity, but there is suddenly much less income, even if there is some element of insurance that comes into play.  And the lifestyle that he has become accustomed to is suddenly out of reach.  With no plan for a second career, it’s easy to see how the player will have little or no net worth along with high fixed expenses.  It isn’t surprising that 15 percent or more will eventually suffer bankruptcy.

There are lessons for the rest of us here as well.  We should all strive to understand the hedonic treadmill and the fact that we are not going to make ourselves happier on a sustained basis merely by increasing our spending.  We should be aware of the risk of making choices that do not increase happiness but do reduce financial flexibility in the future (such as purchasing an expensive car on credit, living in a large home in a suburb 30 miles from work, etc).  If we consider financial freedom at a relatively young age to be intrinsically valuable regardless of whether we wish to continue working, then some thought needs to be given to having restraint in the early years, and that is especially well illustrated by the choices facing a new NFL player.