Sports fans know July 1 as the day that former Mets third baseman gets his annual paystub of $1.9 million from the NY baseball team, even though he hasn’t played for the team in over two decades. How did Bobby Bonilla financially finesse such a lucrative severance package? It all comes down to compounded interest.
Background
Bobby Bonilla re-signed with the New York Mets in the late 90s, but the team released him in 2000 with $5.9 million of his contract still remaining to be paid out to him. Rather than taking the money upfront, Bonilla and his agent offered to defer payment for a decade until 2011, with the agreement that he would receive an annuity of $1.9 million over the course of 25 years. By 2035, when he has been fully compensated, he will have received a total of $29.8 million from the Mets.
But how does that work?
“Interest on Interest”
Compounded interest is based on both initial principal and accumulated interest from previous periods, which is why it’s often referred to as “interest on interest.”
Compounded interest can either work for you or against you. Those who place money in retirement funds and leave it there, allowing interest to accrue, will reap the benefits of a compounded interest. On the other hand, someone with outstanding and deferred student loan payments will find compounded interest accumulating in massive amounts if not handled properly.
In Bobby’s case, the principal is the $5.9 million original amount owed and the accumulated interest is the 8% of interest that accrued over the ten years during which he deferred his salary.
It’s important to note that, since the Great Recession of 2008 when the Federal Reserve slashed interest rates to almost 0%, Bonilla’s 8% return on investment is a rare and generous offer.
Why Did The Mets OK This?
The Mets, who were then heavily involved in a Ponzi scheme with Bernie Madoff, signed on Bobby’s contract, believing that the 10% in returns they would receive from their investments with Madoff would outweigh the 8% compounded interest fee in Bonilla’s contract. However, when the Madoff scheme collapsed, the Mets were still left paying Bonilla’s payments and without their promised 10% cushion.
Lessons Learned
Bobby’s case is a good lesson in long-term investments and how Americans should learn, early on, how to make their money work for them.
July 1st, now dubbed “Bobby Bonilla Day,” is a necessary annual reminder of the effects interest rates can have on debt management.
As Einstein said: “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.”
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