Actors, athletes and tech superstars with substantial incomes and the limelight cast upon them at a very young age (20s and early 30s) are often prone to lavish spending when those first big paychecks come rolling in. It’s hard to blame them, especially when many of us look back at our younger selves and concede that we were, perhaps, mildly irresponsible with how we spent our money. With time, we hope, comes maturity, perspective and the guidance of a sound financial plan.
There are countless stories of celebrity millionaires who earned enough in one year to be financially set for life, yet today find themselves with nothing. To avoid becoming a cautionary tale for the young, rich and famous, we often implement a simple “three-bucket financial plan.” We identify three periods of time, or three buckets in the newly-minted millionaire’s life, and divide their income/assets into thirds to be allocated to each bucket. This strategy allows our clients to enjoy the spoils of wealth responsibly.
Bucket 1: Luxury purchases.
The first bucket allows for the fun and flashy items we associate with the rich. This usually leads to a fancy house purchase, an exotic sports car, a glitzy vacation (with the family/friends entourage), a gift for Mom and Dad, and occasionally a high-end jewelry or art piece purchase. Spending a third of your income on these items offers the immediate gratification/reward for your success that many young stars crave. However, when you’re limited to a third of your income, it automatically caps your spending.
Former National Football League head coach Herm Edwards has a “rule of one” that he shares with NFL rookies — you only need one house, one car, one piece of jewelry – not the Mr. T starter set. We echo these sentiments by capping the desire to splurge at one third of income. This also has a way of reducing the pressure from all the “friends” who want to share in your success.
Bucket 2: Goal-based investments.
Now that we have the fun third of your money accounted for, we next direct a third of your income towards what you hope to achieve. This portion of your income and assets will be allocated towards goal-based investments. We discuss your plans, your ambitions, your brand and your legacy. Perhaps you intend to start a family, have kids that you want to put through college, create a new business or start a charity to give back to a cause or community that you are a part of.
As your income grows, we focus on wealth preservation and asset protection strategies. We coordinate with your accountant, business manager and attorney to set up your estate plan to hold your assets in trust. We may also advise setting up a corporation to allow for write-offs to help reduce your tax liability.
When you’re young and successful you tend to feel invincible and that anything you touch will work out (after all, it has thus far). However, it’s strongly recommended that you avoid risky private equity ventures, such as investing in a nightclub or unproven restaurant – potentially all-or-nothing investments. We also reinforce that supporting a large entourage of friends and family, going through divorce and poor financial management are three of the most common causes for those that have lost it all.
Bucket 3: Retirement.
Finally, and perhaps most importantly, we have bucket three – retirement. This is the portion of your plan designed to give you the desired financial comfort and confidence. It can be comforting to know that you have placed a third of your nest egg in conservative long-term, tax-advantaged investments that you have not touched and that will potentially provide you the results you intended when it comes time to retire. Time and compound returns can be a powerful combination for building and preserving wealth.
It’s important to convey that we do not necessarily view retirement in the conventional sense. You know, where you turn 65 and hit the golf course. Instead, we view retirement as a financial independence — having the means to spend your time and energy how you want, on your terms. For the young, rich and famous, they wouldn’t want to do it any other way.
Written by Joe O’Boyle of US News & World Report
(Source: US News & World Report)