Sound Financial Decision Making

You’ve seen the story before…a famous athlete who earned millions each year suddenly finds that they are filing for bankruptcy in retirement, and each time it occurs it seems so puzzling. How could someone who made such a significant amount of money, year after year, end up with nothing?

There is one reason. They spent more than they made.

A new car here, a new house there…and quickly, their assets have evaporated. To put it another way, their finances took a back seat to their behavior.

Bankruptcy is not an outcome reserved for the lower and middle classes.

But if professional athletes aren’t immune to financial collapse, how can the everyday American avoid such a fate?

Sound financial decision making.

Let’s look at an example.

Fresh Out of College

A student (we will call him Nick) fresh out of college lands his first entry-level job. Seeking to capitalize on his newfound stream of income, Nick begins the search for a brand-new car. After a couple of weeks of searching, he decides on a new Ford F-150, with a sticker price of $28,000.

Now, this may not be such a bad choice, so let’s take a look under the hood of Nick’s financial situation.

Details:

• Salary — $50,000
• Student Loan Debt — $29,500
• Credit Card Debt — $1,500
• Savings — $1500

*Current Car – 7-year old Honda Accord with 85k miles (in great condition)

Earning $50k in salary and carrying nearly $30k in student loan debt – both standard figures for a recent grad – Nick is ready to assume $19,500 in auto loans (assuming Nick chooses not to empty his savings account and is able to trade in the Accord at fair market value for $8,500).

After adding it all up, Nick is looking at a new debt load of $50,500 – slightly more than his annual salary! Now, for those that may not see this as an issue at first glance, let’s break it apart.

Fixed Rent/Debt Payments:

• Rent — $1100/month
• Student Loan Payment — $328/ month (assuming 6% interest on loan; 10-year payment plan)
• New Car Payment – $351/ month (5-year loan)
• Minimum Credit Card Payment — $30/month (assuming 2% minimum payment)

Prior to spending any money for the month, $1809 is already earmarked to service debt and cover rent- more than half of the approximately $3400 he expects to take in after taxes. Now factor in the costs for health insurance, car insurance, gas, food, phone, internet and clothing. Nick may quickly find that he is overextended.

What if Nick’s best friend has a destination wedding in the coming year? How would he cover that cost?

Shopping, travel, and entertainment become unrealistic luxuries.  Retirement and other savings…yeah, right.

Expenses add up quickly and keeping up becomes far more difficult when more than 50% of the income is already spoken for. All too often the solution to not having enough funds to cover the lifestyle becomes…more debt.

Choices

Instead, Nick could very well choose to forego the new car for a while, and free up $351 of cash flow each month. By establishing a buffer, Nick would be better positioned to set aside some savings (for an emergency or unexpected expense, like a health bill or car repair) or to pay more toward his student loan (you know, the debt he accumulated prior to entering the workplace). He may even be able to save up for that wedding.

With one decision, he could relieve a great deal of the stress and anxiety that comes from being backed into a corner financially each month…it just requires a choice.

While this may seem like a far cry from an athlete splurging on one too many luxury cars, or an outsized house, the premise is the same.

Spend more than you earn, and you will find yourself in a hole…incredibly quickly. With more debt used to maintain a lifestyle, the problem compounds itself. The amount you owe others grows, and grows, and grows, until it is too much to handle.

Choose wisely.