Written by: Corey Janoff
This post was originally published on our previous blog website on January 17, 2018 and has since not been revised and/or updated.
For those football fans out there, you probably heard the Oakland Raiders recently agreed to pay Jon Gruden $100 million (reportedly) over ten years to be their head football coach. If Gruden leads the Raiders to a Super Bowl victory in the next decade, it will be worth every penny. But does it really make financial sense to guarantee $100 million to someone who hasn’t coached in almost a decade?
Over the last several years, every time there is a head coaching vacancy in the NFL or at major college football programs, Jon Gruden’s name gets brought up. In the last month or so, the University of Tennessee reportedly was aggressively pursuing Gruden, as well as the NFL’s Tampa Bay Buccaneers (the team Gruden won a Super Bowl with in 2003). Once the Oakland Raiders joined the party, the price to get Gruden to leave his cushy broadcasting career rose. Oakland outbid Tampa Bay and won the Gruden auction.
The price would have to be high to get a guy to leave a gig where he was reportedly getting paid $6.5 million to work one day a week for four months per year.
This is a classic case of overpaying for perceived value. When demand is high, the price goes up. Who knows if the results will pan out moving forward? There are two scenarios when this overpaying phenomenon happens.
Scenario 1:
Recent success, or consistent success over a period of time, will lead people to believe that the success will continue. While this very well may be the case, there are plenty of cases when the success peters out or screeches to a halt. I have brought up internet stocks in the 1990’s in previous blogs, as well as real estate in the mid-2000’s. Both were scenarios where investors thought that the only direction those investments could go was up.
Continuing with the football analogy, this would be Bill Belichick (head coach of the New England Patriots). He has realized both recent success (2017 Super Bowl champion) and consistent success over a period of time (seven Super Bowl appearances and five Super Bowl victories as a head coach since 2001). He is deservedly the highest paid coach in the NFL at $12.5 million per year.
If Belichick wanted, he could probably demand $20 million per year from the Patriots to remain the head coach. And if they let him leave, some other team would gladly pony up that money to have him be their head coach. Coaches’ salaries don’t count against the salary cap in the NFL, so you can pay a coach as much as you want.
Would that be wise though? At almost 66 years of age, how much more does Belichick have left in the tank? Also, is Belichick’s the one that possesses the magic dust, or is he a beneficiary of other key ingredients in the Patriots organization (ahem, maybe the Patriots’ quarterback, Tom Brady)?
That’s the risk when you overpay for something. The results moving forward may not be the same as they were in the past, leaving you with buyer’s remorse. You are only satisfied when the previous results continue moving forward.
Scenario 2:
The second scenario where people overpay for perceived value is the Jon Gruden scenario, which is speculation. There isn’t a great long-term track record of success. Maybe a very short run of amazing, which leads us (and others) to believe there is more where that came from.
You see this all of the time with young college football coaches who take a historically mediocre or dismal college team and turn them into a powerhouse in just a couple of years. The coach often gets a big payday from a major university, or NFL team. Sometimes it works out well, sometimes it backfires. See Chip Kelly.
We see this with investments every year. Some niche investment catches the public and the media by storm and everybody wants in. We think it will be “the next big thing.” Recently that has been cryptocurrencies. A few years ago, 3D printing had its 15 minutes of fame. Solar and wind energy was all the craze about 10-15 years ago when we thought the world was running out of oil.
Now, don’t get me wrong, all of these areas could prove to be an integral part of our society and be great investments long-term. Only time will tell. However, people looking to make a big gain may have to wait awhile. The solar and wind investors from a decade ago are still holding on to the potential promise that their investments will turn a good profit if those forms of energy become the preferred energy sources for our world.
Speculating is not much different from gambling. You have a hunch that this could be a winner. You also realize it could backfire and you won’t see any of your initial investment returned to you.
This is how venture capitalists make their money. They throw money at ten different projects, knowing full well that nine of them will flop. But if they can get one out of ten correct, it should work out in their favor.
Know the Risks
There is nothing wrong with speculative investing, or overpaying for potential. If Jon Gruden realizes his potential, it will be the best investment the Raiders have made in over 30 years. But you better be able to afford the losses if things don’t work out.
In the Oakland Raiders case, $100 million is a lot of money, but even if they don’t achieve their goal of winning a Super Bowl, I don’t think this will bankrupt them. Heck, they would probably be spending $60-90 million over the next decade on a head coach anyways. If it doesn’t work out, they can find another coach. For a franchise that Forbes estimates to be worth $2.4 billion, it’s manageable. If you can afford it, why not swing for the fences?
If your investment flops and you are left with nothing, will that derail your ability to ever reach your financial goals? If so, you might want to think long and hard about it.
Make sure you are financially stable and on a good track before making these types of investments. If all of your goals are adequately funded and you have some excess money, then sure, go for it.
Disclosures:
These are the opinions of Corey Janoff and not necessarily those of Finity Group, LLC or Cambridge Investment Research, Inc. Any examples are hypothetical and for illustrative purposes only. Any investment involves potential loss, including total loss of principal. Consult with your financial advisor before making an investment.
