October 26, 2023
The “Rise of the Machines…”Maybe Not So Much
The question of whether Artificial Intelligence (AI) could or will take over the world has become a topic of great fascination and concern as technology continues to advance and AI becomes increasingly sophisticated. This ongoing conversation has been fueled by the advent of Chat GPT, along with the exponential growth in computing power.
In the realm of investments, a significant shift occurred approximately 15 years ago that could be seen as a form of takeover, specifically the potential extinction of the traditional financial advisor. Born out of the aftermath of the 2008 financial crisis, the founders of Betterment sought to revolutionize the world of financial planning by creating a platform that relied solely on computer algorithms.
The concept of robo-advisory, at its core, involved individuals completing a detailed questionnaire about their financial situation, goals, and risk tolerance. In return, they would receive an ideal investment portfolio generated by an algorithm. This approach offered the advantage of discovering the most efficient portfolio for an individual while eliminating the cost of a human advisor.
However, it is important to consider what was overlooked in this approach. While the cost of a human advisor was eliminated, so too were their experience, judgment, emotional intelligence, empathy, and genuine concern for the investor’s well-being and their family. These elements turned out to be elemental in guiding investors through various market movements and managing their investments with care.
The fundamental flaw: An algorithm cannot override human instincts, which play a vital role in determining long-term investment outcomes, making it a critical factor in programmed investing. Yes, there may come a day when the machine advises an investor to increase their exposure to equities during market crashes, while human nature urges them to hold cash. Similarly, the machine may suggest reducing holdings in performing sectors and reinvesting in underperforming areas, challenging the investor’s instinct to capitalize on soaring sectors.
On such occasions, human nature will prevail, prompting the investor to switch off the machine. This clash between the ruthlessly logical algorithm and essential human temperament demonstrates that human nature will always triumph, to the detriment of the investor.
The prevailing notion that artificial intelligence will effortlessly unlock successful investing, freeing investors from the inefficiencies of a human advisor, overlooks a crucial question: Who will emancipate us from our own human nature? Who will empower us to overcome fear when equity prices plummet, enabling us to seize investment opportunities during periods of uncertainty? Who will ensure we maintain a diversified portfolio when the financial media glorifies a fund manager who outperforms the S&P 500 in a market segment that may be difficult for us to understand? These questions are not meant to be answered, but rather to highlight the importance of having a trusted advisor who genuinely cares about an investor’s well-being and can offer guidance during critical moments in their investment journey.
While discussing AI, it is also worth mentioning that true interest in AI will only arise when it reaches a stage of development where it can be implanted in the human brain, overriding our own biological systems, a kind of singularity. It would be useful in that our own systems, responsible for extreme fear and excitement, often lead to irrational investment decisions.
Until that time, it is far more likely that the most reliable defense against an investor’s worst and most human instincts lies in having a dedicated advisor who can provide valuable guidance and is not afraid to say, “Why don’t we get a cup of coffee and allow me to offer you a second opinion on that?”