Finance Expert Michael Thomas Busts Investment Myths
Future financial planners should be prepared to dispel their clients’ myths when it comes to helping them make wise investments, according to guest lecturer Michael Thomas, who presented “Mythbusters—Lessons Investors Would Do Well to Unlearn,” to Carson College students.
Thomas, a CFA charterholder, is Russell Investments’ managing director of fiduciary solutions and responsible for creating investment strategies for the firm’s retirement plan clients.
Thomas explained clients sometimes do not follow the firm’s advice because they misunderstand some fundamental investment concepts. He referred to these misunderstandings broadly as “investment myths” and spoke to those frequently associated with inflation and investment decisions.
Inflation
Investment myths, such as “monetary expansion leads to inflation” are often based on slivers of truth, Thomas explained. For example, when people observe the Federal Reserve increasing the amount of funds at depository institutions, they assume inflation is coming. The sliver of truth is that an expanding monetary base can be associated with inflation. However, it is unlikely to be the cause of inflation, he said. “The economy would have to be at full capacity, and the money velocity would need to be flat or increasing. Also, the money multiplier would have to be flat or increasing.”
The key message, he said, is that while the fear of inflation is rational, linking the prospect for inflation to the money base alone is not. “Our brains are a ‘believe what you see’ organ—wired to think fast with the least amount of effort,” he said. “Encouraging clients to take time to think things through can lead to more effective investment decisions.”
High returns
Another common myth is that higher returns are always better than lower returns, Thomas said. Take for example, a 65 year-old retiree with $1 million in savings who withdraws $50,000 annually, and present him with two investment portfolio choices: a high return option comprised of 65 percent equities/35 percent global bonds with an expected annual return of 7.0 percent, and a low return option comprised of 10 percent equities/90 percent bonds with an expected return of 5.0 percent.
Most investors would select the portfolio with the higher expected return, but in practice, most investors want to avoid or minimize the odds of financial ruin, Thomas said. In this scenario, the higher returning portfolio is more than twice as likely to end in financial ruin than the lower returning portfolio (21 percent versus 9 percent). “The reason for this is negative cash flows,” he said. “In the face of cash flows, the sequence of returns matters a lot. Risk deserves at least as much attention as the expected return.”
Importance of critical thinking
The biggest challenge investors face is jumping to conclusions, Thomas said. “I encourage you to think critically,” he said. “Be wary of casual associations you or others may make—give yourself the time to really understand the details.”
Thomas was accompanied by Bryan Weeks (’85 Fin.), a CFA charterholder and Russell Investments’ head of Americas Institutional Business, who spoke briefly to students at the end of the presentation about his career path and managing a client base. Weeks serves on the college’s National Board of Advisors Executive Committee, chairs the International Business Advisory Board, and often volunteers to share his expertise with WSU students.
The presentation was sponsored by the Department of Finance and Management Science in the Carson College