Tag Archives: personal finance

Former NFL Players Declare Bankruptcy at Alarming Rates

Thesis: The NFL should institute a league wide mandate requiring players to save money for retirement.

It has been widely documented the financial distress that former NFL players find themselves in after they stop playing. This can be attributed to many reasons, but so far has had no solution emerge. Leigh Steinberg writes that, “Sports Illustrated recently estimated that 80% of retired NFL players go broke in their first three years out of the League.” This seems like an anomaly since the average NFL salary is almost $2 million per year. However this number is much higher due to some superstars’ outrageous salaries. “The median income in the NFL is roughly $750,000 and the average career span is less than four years.” This is still a lot more money than most people will make in their entire lives.

A separate research paper released in the National Bureau of Economic Research “found that 15.7% of [NFL] players file for bankruptcy within 12 years of retiring from the league, with little difference based on career length or earnings.” The researchers were attempting to test the “theory of consumption smoothing, that people will save more when their income is high to help cover future expenses when their income will be lower. NFL players offer an extreme example of people with large but short-lived income spikes.” The results are different than what would be expected from current life-cycle model predictions, but that is not what I am here to discuss right now.

The NFL is in a prime position to try and help their current and future players better manage their money. They have started requiring NFL draft picks to attend rookie seminars trying to offer financial and career advice for these rookies, but it is up to the athletes to take the suggested actions. I propose that the NFL along with the NFLPA (National Football League Players Association) make a league wide mandate requiring NFL players to put 10% of their salary in savings.

This can be accomplished by implementing 401k’s among other plans to be offered by each team that each player must put at least 10% of their salary into. This will help reduce the amount of financial distress that former NFL players have, as well as cast a better image on Roger Goodell by showing that the NFL cares about and supports their players. While the NFL does already have a retirement pension plan in place for former athletes, and offers 2 for 1 matches up to $24,000, they do not require players to make contributions.

This will cause players to learn to spend less money, as they will be receiving smaller paychecks, and also help these players build their retirement nest egg as they are required to save about $75,000 per year. For an average NFL player this will result in over $300,000 saved over their average four year careers. While this will certainly not eliminate ALL bankruptcies of former NFL players, it will help lower the number. This requirement along with educational sessions on budgeting and saving, should help these elite athletes better save their money and reduce the number of bankruptcies declared within a few years of retirement from the league.

New Financial Advisor Regulation will have little impact

Thesis: Obama’s regulations for the financial advisory industry will have little impact on advisor behavior.

President Obama last month said in a speech to members of the AARP (American Association of Retired Persons) that he has given the Department of Labor the permission to change its rule and the definition of fiduciary under the Employee Retirement Income Security Act. This simple change of one word’s definition has people in the financial advisory industry worried. The reasons behind this proposed change are obvious, to require the financial advisor to act in the best interest of their clients and disclose any and all fees associated with all potential investments ahead of time. Obama and his supporters argue here that the reasons for this this proposed rule changes are “that consumers are entitled to unbiased information, and that commission-based compensation structures generate inherent conflicts of interest.” The opposition argue that these changes will cause advice to “become more expensive or not available at all for small accounts or individual plan participants.” I am going to argue that these proposed changes will have almost no impact on advisor behavior.

I make my assertion that these changes will have little to no impact on advisor behavior because I am assuming that clients are going to be acting in the best interest of themselves and their own well being. If these clients are acting in their own best interests, then over time advisors who are charging higher fees for not acting in the best interest of the client will be weeded out. This is because if two advisors are identical and offer the same investment advice, but one, acting in the best interest of the client, invests their client’s money in a lower fee mutual fund, while the other advisor, not acting in the best interest of their client, invests the money into an equal mutual fund but one that charges higher fees for themselves, the returns for advisor #2 will be lower after all fees. This lower return will, over time, cause clients to switch advisors and go to the one who is acting in the best interest of their clients. They will do this whether or not they even realize if their current advisor is acting in their best interest because the returns will, on average, be lower for financial advisors not acting in their clients best interests. This process will act as a filter in and of itself to remove financial advisors who aren’t acting in the best interest of their clients. Over time, as people realize they are not getting the most out of this relationship, they will move their money to advisors with higher returns who already act in the best interest of their clients.

Even though as Jason Zweig writes in his article, “Mary Jo White, chairman of the SEC, voiced her view that stockbrokers, insurance agents, and other financial salespeople should have to put their clients’ interests ahead of their own” making any changes to the wording of the rules in place will not significantly impact on financial advisor behavior.

Why Rebalance?

Much of the below discussion draws from the chapter on Dynamic Portfolio Choice from Andrew Ang’s Asset Management — a book I highly recommend

Comparing the return performance of rebalanced and “buy-and-hold” portfolios says little about the economic value of one strategy or the other. In a recent blog post, Corey Hoffstein shows that returns to rebalanced portfolios underperform in times of trends, and as such finds the evidence in favor of rebalancing to be quite mixed. But because there is no explanation of why rebalancing makes sense and how it creates value, return data tells relatively little about whether you should rebalance or not.

First let’s set the stage. Suppose you’re a long term investor with a million dollars and a time horizon of 25 years. And suppose that in this world the distribution of returns is assumed to be the same in each period, (iid), that you can trade once every year, and that you do not have access to any “inside tips” that would tell you any information about the distribution of stock returns. The first assumption is reasonable because if everybody knew returns were going to be high tomorrow, they would just buy today. The second is just for simplification, and the third one reflects the situation of most individual investors without access to any kind of special research team (not that institutional investors have access to the secret sauce either)

In this world, there are two broad classes of trading strategies: static and dynamic. A static strategy just buys and holds. Set up your 60/40 stocks/bonds portfolio and wake up 25 years later, collecting whatever capital gains you get. A dynamic strategy changes how much to buy and sell in each period depending on your wealth. Rebalancing refers to the dynamic strategy of starting out at a certain portfolio allocation, say 60 percent stocks and 40 percent bonds, and in each period selling or buying to go back to this allocation. So if stocks do really well one year while bonds do poorly (say in 2013), then sell some stocks and buy more bonds.

Apriori, it would be strange if a dynamic trading strategy were dominated by static trading strategy. Under the conditions I described above, rebalancing does dominate because it allows you to reset your risk exposure every period.

To see why, change the perspective from thinking about the trades you’re doing and instead think about the decision to change your risk exposure over time. Start from the assumption that your risk aversion does not change over time. If you fail to rebalance, as the share of stocks in your portfolio increases over time, you are choosing to increase your overall exposure to your stock market. But wait! If if it’s optimal for you to hold that riskier balance in the second year, then you should have held that in the first year! Expected returns haven’t changed, nor have your preferences. So don’t let the name of “buy and hold” fool you. Just because you’re not trading under a buy-and-hold strategy, you are making an active choice about your risk exposures.

But why does rebalancing create value? The market in aggregate cannot rebalance —if you’re selling stocks to rebalance, somebody has to be buying them from you. If you’re earning a rebalancing premium, there has to be some reason why others are willing to pay you.

Here is a point that Corey does hit on — rebalancing doesn’t work if prices are trending upwards over a long period of time. Another way of putting it is that if the distribution of returns changes over time, a strategy of rebalancing will have you buying more into stocks that may be worth nothing one day. In other words, rebalancing is a strategy that is short regime changes. Rebalancing works great if tomorrow’s returns look like today’s. It’s a horrible idea if, like in 1990’s Japan, stocks collapse and don’t come back even after 20 years.

And here’s why there is a long run rebalancing premium — you’re protecting others from extreme changes in the market environment. So rebalancing is good for keeping risk exposures on time, but at the risk of black swan events that permanently change the landscape of returns.