Bobby Bonilla, the New York Mets, Bernie Madoff, Warren Buffet, and You

July 1^st is an extraordinarily special day in the world of sports: it’s Bobby Bonilla day. Every year the New York Mets pay former player Bobby Bonilla more than $1,000,000 despite the fact he hasn’t played for them since Bill Clinton was president. Today I bring you the tale of how an extraordinarily poor plan by a professional baseball team teaches us basic lessons for getting rich over the long-term. You don’t have to know baseball to love this astounding tale.

An introduction to Bobby Bonilla

Early on his professional baseball career Bobby Bonilla was believed to be The Real Deal™. His stats were solid, his potential was huge, and teams wanted to get on board in the hopes he proved to be a superstar. As a kid I remember clearly how significant it felt to open his rookie card in a pack of baseball cards.

Ultimately the New York Mets won the rights to Bonilla by making him the highest paid baseball player in the league at that time for $29,000,000 in 1991 dollars. Over the next few seasons Bonilla turned out to be a solid player with reasonable stats and a few All-Star Game appearances but fell short of the superstar the Mets had hoped for. Some off-field issues caused him additional problems in New York and he was eventually traded. For the next few years Bonilla bounced around to different teams in professional baseball.

In 1998 the New York Mets reacquired Bonilla but found themselves facing the same issues: he underperformed athletically and had issues off the field. The team decided to move on and released him but in order to do so they had to deal with $5,900,000 they still owed him on his contract. Deciding they wanted access to the money immediately the Mets agreed to a deal to pay Bonilla what they owed him at a later date with a “small” amount of interest so that they could spend the not-quite-$6,000,000 on rebuilding their team right away. Bonilla agreed to the deal.

The terms? Starting in 2011 the Mets would pay Bobby slightly more than $1,000,000 each year through 2035 totaling approximately $30,000,000 based on an 8% interest rate on the almost $6,000,000 in outstanding salary. The official stat books list Bonilla’s career home run total as a professional player at 287; it should read 288, his final home run the extraordinary deal he snookered the Mets into agreeing to.

When you bet against the most powerful force in the universe

I’ve talked at length about the most powerful force in the universe: compoundinterest. In every circumstance you should be conspiring to get that incredible force working in your favor. It’s why debt is so deadly (pay it off like a game or pay it off with the most powerful debt reduction method) because you’re arming someone else with the most powerful force in the universe to use AGAINST you.

That’s exactly what happened to the New York Mets. In a rush to free up $6,000,000 to spend on improving their roster RIGHT THEN they gave someone else the most powerful force in the universe. Compounding at 8% Bonilla’s $6,000,000 became $30,000,000 and a commitment for repayment that will take decades to repay. The Mets bet spending the $6,000,000 in 1999 was more profitable than having $30,000,000 in 2011.

The extraordinary thing about the deal the Mets agreed to was the interest rate. Bonilla’s agent, Dennis Gilbert, had initially proposed a 10% interest rate. The Mets came to the negotiations with 6%, and the sides met in the middle at 8%. Is 8% a good number? Absolutely! But why?

In “What to Buy When Buying Stocks,” I talk about index funds, the absolute best option for common investors like you and me when investing our money. In an index fund the fees are very low because you’re not paying a hotshot to pick stocks for you; instead you bet on the market to grow over time. Indexes are trusting that capitalism works. One of the most common benchmarks for index funds, the S&P 500, has a 100 year cumulative rate of return of about 7%. That means money invested in the S&P 500 generates about 7% each year, and that’s the benchmark I use for looking at all investments. Whenever opportunities come up for investing I ask myself, “After costs and fees does this investment beat the 7% I could get by just parking my money in an almost-fee-free index fund following the S&P 500?” To date the answer has always been “No.”

So back to Bobby Bonilla and the Mets. Under the 7% lens what Bonilla’s agent managed to pull off was extraordinary. He guaranteed his client a rate of interest better than the S&P 500, and the rate was guaranteed! Remember that while the cumulative return on the S&P 500 is 7% the yearly returns ebb and flow. Over time you wind up with 7% (historically), but in a given year you could be way up or way down. Bobby Bonilla? Not so much: his contract guaranteed him his interest rate regardless of what happened elsewhere. The fact he beat the market’s rate and that that victory was locked in made his deal such an extraordinary win. Why on earth would an organization as sophisticated as the New York Mets be willing to give up that rate of return when they certainly knew about the 7% rule?

Betting against the world’s richest man

Copyright Wikipedia

Warren Buffett is a smart man. Sometimes called the world’s smartest investor he has made an extraordinary career investing other people’s money and then later running his own company, Berkshire Hathaway. A single share of stock in his company will set you back about $250,000. He is constantly jockeying with Bill Gates and Carlos Slim for the title of “World’s Richest Man” and has famously avoided the follies of others in investing by sticking with a seemingly obvious strategy: buying companies that offer value to their customers and profitability. His greatest hits include dodging most of the 2000 internet stock market crash by not buying into now infamous whipping boys like Pets.com, seeing through the hype and weathering criticism so strong people questioned whether he should remain in charge of his own company.

I’ve written previously about Warren Buffett’s thoughts on investing in the modern world. Despite being an investment genius he strongly believes in the power of index funds for investors. In fact, he believes so strongly in them that he actually bet $500,000 against high powered hedge fund managers that a vanilla S&P 500 index fund with low fees would beat in performance their human-managed funds with higher fees. How did he do? He is currently crushing the competition and the interest rate for the nearly 10 years the bet has been going on is almost exactly the historical rate: 7.1%.

So you have one of the world’s smartest investors who says 7% is so awesome as a benchmark he’ll bet hundreds of thousands of his own dollars against fancy moneymen who think they can outsmart him. Then you have the Mets who are willing to give up 8% returns to free up immediate cash, presumably because they think they can beat that rate. What would have led them to believe that?

It could simply have been the same type of hubris that led those hedge fund managers into believing they could take on Warren Buffett and win. Unfortunately for the Mets it was something far more nefarious: the largest Ponzi fraud in United States history. See, the reason Mets owner Fred Wilpon was willing to give Bobby Bonilla 8%, beating Warren Buffett’s target of 7%, is because Bernie Madoff was promising Wilpon returns of 10-15%. With the promise of higher returns on that money Fred Wilpon was having his cake and eating it too: he could take money for Bobby Bonilla right now, spend it with Madoff, and pay Bonilla less than what he earned in interest even at 8%. As for Bernie Madoff? He was using that money to pay off investors who were constantly joining his scheme, which is how a Ponzi scheme is organized: new investors put money in that is paid back to older investors so that it looks like you’ve got returns that consistently beat even the S&P 500. The trouble with Ponzi schemes is that eventually you run out of money to keep paying upwards and the whole house of cards tumbles down.

So the Mets wanted $6,000,000 to spend on new players. Bobby Bonilla (and his agent) wanted a rate that beat the 7% S&P 500 index. Fred Wilpon wanted to keep making money from investing with Madoff. It all conspired into the deal that sees Bobby Bonilla making more this year than over a dozen baseball players who will actually suit up for the Mets in 2017 and payoffs that will continue until he’s in his 70s. July 1^st will be “Bobby Bonilla day” for decades to come.

The lessons for us

The Mets made a bad bet, Bobby Bonilla and Dennis Gilbert made a great bet, Fred Wilpon made a terrible bet, and Warren Buffett only makes good bets. What does that all mean to you and me on the path to getting rich?

·         Lesson 1: Compound interest is powerful! The reason Bobby Bonilla could go from being owed $6,000,000 to $30,000,000 is compound interest. There’s a reason I call it the most powerful force in the universe! If you owe someone money you’re arming them with compound interest to use against you so pay off that debt! And take advantage of your IRA, HSA, and 401k options to arm yourself with compound interest and turbo charge your wealth accumulation.

·         Lesson 2: Don’t bet against Buffett! The Mets thought they could beat the 7% Warren Buffett is willing to bet hundreds of thousands of his own dollars on. They were wrong. If an organization that large thinks they can beat Buffett and can’t, what hope do you or I have? The answer is none, but that’s not a bad thing. A 7% rate of return is great! With a 4% safe withdrawal rate you have 3% left over to account for inflation meaning you can happily retire on a return of 7%. It’s hard to beat the American economy when it comes to investing.

·         Lesson 3: If they can consistently beat the American economy when investing, they’re probably a scam. The old adage is still relevant: if it sounds too good to be true, it probably is. If anyone offers you consistent returns higher than indexing the stock market RUN. Run as fast as you can, as far as you can, because they’re almost certainly a scam. Even if they’re not the fees they’ll charge you to get those returns will nullify gains with using them. And if that’s not true than relax: you and I aren’t the people that get those types of investing opportunities. The mega wealthy, like Fred Wilpon, got taken in by Bernie Madoff because they believed with their wealth they could access deals casual investors like you and me can’t. Madoff knew that and took advantage, his returns a mirage that eventually was revealed to be unable to beat the market. The hedge fund managers confident they could beat Warren Buffett’s index? Also wrong. Run from these people as quickly as you can.

·         Lesson 4: If your stock guy has a name that is literally pronounced, “Made off” you’re probably getting scammed. Okay, so this one is a lot less scientific but what are the odds Bernie’s last name would be pronounced, “Made off” as in, “Made off with billions from defrauded customers.” Crazy.

Happy Bobby Bonilla day!

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