Data & Research April 21, 2015

Even NFL Players Could Use Retirement Planning Help

A recent National Bureau for Economic Research study offers some telling stats about the challenges of retirement: Even wealthy NFL players struggle to create a reliable plan for the future.
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Initial bankruptcy filings among National Football League (NFL) players begin very soon after retirement and continue at a substantial rate through at least the first 12 years of retirement, according to a study published by the National Bureau for Economic Research (NBER).

Researchers from the California Institute of Technology, University of Washington and George Washington University set out to test how the life-cycle hypothesis applies in a group of people whose income profile does not just gradually rise then fall, as it does for most workers, but rather has a very large spike lasting comparatively few years. One of the central predictions of the life-cycle hypothesis is that individuals smooth consumption over their economic life cycle; thus, they save when income is high to provide for when income is likely to be low, such as after retirement.

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A perfect test sample for this income spike is professional athletes, so the researchers used data for NFL players drafted by NFL teams from 1996 to 2003. They note that a career lasting six years (the median length) will provide an NFL player with more earnings than an average college graduate will get in an entire lifetime, plus a modest pension. Reduced income in retirement and the uncertainty of their career length are presumably known to players, so the researchers assume that to maintain a smooth level of consumption after the predictable post-NFL income drop, a rational, patient player should save a large portion of his NFL earnings and enter retirement with a high net worth.

However, the study found 1.9% of nearly 900 players in the sample filed bankruptcy by their second year of retirement, and 15.7% filed bankruptcy by their twelfth year. Using regression analysis, a very pessimistic prediction gives a bankruptcy rate of around 40% by 25 years after retirement.

The median level of earnings across all players is about $3.2 million (in year-2000 dollars). The study found players with longer careers have much greater earnings and opportunity to save for retirement, yet their bankruptcy rate during retirement is no lower than those with shorter careers and lower earnings. In addition, the bankruptcy rate of retired football players is in line with that of the general population of that age group (from early 20s to age 34).

Documents on the NFL Players Association website indicate NFL players are offered an annuity program, with payments beginning at the age of 35, or five years after his last credited season in the league (whichever is later), a savings plan in which players can defer income and teams may contribute a 2-for-1 match, and the Bert Bell/Pete Rozelle NFL Player Retirement Plan, which offered a monthly benefit of $470 per credited season in years 1998 through 2011 and $560 per credited season in years 2012 through 2014.

The researchers say future work will focus on what types of players have higher bankruptcy risk, perhaps indicating behavioral biases, correlates of predictably poor financial decision making, and social variables.

“This evidence should also inform helpful interventions, both for these athletes and for other workers with unusual income profiles,” they conclude.

The study report is available for purchase or a free download here.

Data & Research April 21, 2015

The Trouble with Risk Questionnaires

Qualitative risk tolerance assessments are ambiguous and unhelpful to investors, says a new white paper.
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The problem, says Aaron Klein, chief executive of Riskaylze, is the very subjective nature of the questions and the questioner.  “Psychological and qualitative questionnaires are subjective,” Klein tells PLANADVISER,  “because someone is always tasked to weight the various answers into some kind of score or result, and that is inherently a judgment call on the part of the designer.”

In “Using Risk to Manage Client Expectations: How to Gain ROI by Talking about Risk Instead of Returns,” Riskalyze examines the flaws of age-based risk stereotyping and discusses how properly approached conversations about risk can substantially improve quality of life for both advisers and clients.  

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Access to digital and mobile technology offers clients almost unlimited information in real time as never before, the paper notes. Advisers as a result are experiencing ever-increasing challenges in managing client expectations and communication about investment performance.  When the risk discussion focuses on returns or ambiguous risk tolerance cohorts such as “conservative” or “aggressive,” the resulting communication gap can be harmful to firm efficiency and the adviser/client relationship, Riskalyze contends.  

Most questionnaires anchor their results on the stereotype of age, Klein says. Then the questionnaires allow the other questions to nudge the person a bit to the conservative or aggressive sides, depending on their answers. “The results of many of these questionnaires are ambiguous and subjective,” he believes, citing the description “moderately conservative” as particularly suspect.

Age-based stereotyping in risk discussions can lead to serious misalignment, with anywhere from 26% to 53% of clients falling outside their stereotypical age-based risk tolerance buckets. The misalignment is demonstrated across all age brackets, with 53% of clients over age 70 invested outside their risk preference.

“Building a portfolio on this basis is the equivalent of your architect telling your contractor to build a moderately conservative hallway leading into a moderately aggressive bedroom and expecting things to work out,” Klein says. “There’s a reason we adopted feet and inches in construction, and we need to make the jump to quantitative benchmarks in investing as well.”

Riskalyze recommends that advisers concentrate on educating clients about the uniqueness of their own quantitative Risk Number. According to Mike McDaniel, chief investment officer at Riskalyze, the correct way to define individual risk preference is to determine how far their portfolio can fall within a fixed period of time before they capitulate and make a poor investing decision.

“The net effect of using numbers instead of conjecture to discuss risk is happy and satisfied clients, regardless of which way the market is swinging,” McDaniel says.” This in turn leads to greater efficiency, productivity and client relationships.”

Riskalyze, in Auburn, California, works with registered investment advisers (RIAs), hybrid advisers, broker/dealers, custodians, clearing firms and asset managers to align the world’s investments with investor risk preference.

“Using Risk to Manage Client Expectations: How to Gain ROI by Talking About Risk Instead of Returns” is available for download from Riskalyze’s website.

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