Maybe it is just me but it seems as though there are more stories about actors, athletes or the famous running into financial troubles. People that have made tens of millions over their careers that you would expect to be financially set for life. In doing a little research, we found what we expected; six common themes that lead to their ruin that are mostly avoidable.
Sports Illustrated published a study that found that 78% of NFL players filed for bankruptcy within two years of retirement from football. The NBA fared better at five years and 60% but still startling.
Some of the famous professional athletes that have filed for bankruptcy or have been publicly reported to have hit hard times (name and estimated lifetime earnings in millions): Holyfield-250, Taylor-50, Pippen-120, Sprewell-50, Vick-130, Tyson-300, Laettner-60, Ismael-20 and Clark-20 to name a few.
Entertainers are not exempt with well publicized financial troubles hitting Kim Basinger, Mick Fleetwood, Willie Nelson (16.7 million IRS debt at one time), Larry King, Tom Petty, Elton John, Walt Disney, Burt Reynolds, Wayne Newton and the list goes on (going all the way back to include Mark Twain and Rembrandt).
Some people say our currency is bankrupt today and that may be somewhat true with Grant, Lincoln and Jefferson all declaring bankruptcy at one time. One other President, William McKinley filed for bankruptcy protection as well.
We have left off a famous lottery winner who blew 16.2 million, but you get the idea—money only allows for financial security only if you steward it well. So what are some of the common themes to the downfall? Most of the troubles seem to stem from the same common challenges everyone encounters: over spending, divorce, legal problems, leverage, really bad investments and tax troubles.
When you make hundreds of millions and lose it, that means you did not follow the number one rule for wealth creation, pay yourself first. Take a portion of your earnings, carve it off and put it aside in liquid diversified investments. BORING. Maybe but it works.
Leverage can be a key to making great wealth but it is also a common cause of financial destruction. For example, if you borrow $800,000 on a $1,000,000 property and the value increases 20% to $1.2mil, you just made 100%. How can that be? Well, you invested $200k and the bank put in the remaining $800k. If you cash out this hypothetical transaction assuming no costs involved, you get $400k (1.2m-800k), doubling your initial investment.
Let’s make it go the other way, the property loses 20%, dropping from $1mil to 800k in value, you now lost 100% of your investment.
People borrow money to buy their home, but what generally happens if they can’t afford the mortgage any longer? It gets foreclosed and their credit is tarnished but generally their other assets are untouched. But if you take out loans for business ventures or real estate investments, those structures are often recourse against your entire net worth vs. just the property (non-recourse).
Affluent people that get into business with less financially well off partners often times come to the shocking realization that they are the target of collection if something goes wrong. Just because you are one of the partners in a deal gone south, does not mean that all the partners will be sought after for collections.
Most loan agreements do not separate out the liability per the percentage ownership in a deal. The lender often times comes after the deepest and easiest pocket to go after, leaving the partners to figure out how to settle up amongst themselves.
The overspending issues in the country are a societal problem that applies to the wealthy as well. Why would anyone think that the more money people make, the more they would save? That means there is more to spend. And that is one if not the biggest problems that we saw in a lot of these downfall stories. People making a lot, spending more, taking on debts to fill holes.
When people follow this path, they seem to pay less attention to one major bill, the IRS. Whether it is the attempt to initiate tax dodges that don’t work, taking aggressive positions or simply not paying, you don’t want to ever get into a situation where you have to liquidate assets to pay the government (e.g., Nicholas Cage most recently).
When it comes to investments, maybe it is the artistic side of the mind or the aggressive “win at all costs” mentality in athletes but they tend to make some really bad decisions. The usual culprit is the restaurant, night club, business with friends or a land development deal. These are all investments that typically carry tremendous risks and leverage. Of course the BORING stuff does not appeal…that only appeals to someone like Warren Buffet (3rd ranked wealthiest person in the world…living in his same Omaha house he bought in 1958).
All of the people in this story could have been financially well off forever. If they had only followed the “boring” path to financial success. The tortoise wins more often than you would think. But it’s not EXCITING. Though financial distress is?
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Author’s Note: Brad Stark, MS, CFP, AAMS, CMFC and Seth Streeter, MS, CFP are Co-Founders of Mission Wealth Management, LLC, a Registered Investment Advisor. The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action. Securities offered through National Planning Corporation, Member FINRA/SIPC. NPC and MWM are separate and unrelated entities. Certain statements contained within may be forward-looking statements, including but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties; all statements are subject to change without notice. Also, historical performance cannot predict future results.