Algorithms effectively run our lives in ways we seldom notice. They determine the next song on your playlist or the recommendations for what you should watch next. They suggest other items to add to your online shopping cart, the best route through today’s traffic, or people you might want to link up with on your social network.
More serious implications are found in the realm of personal finance. You negotiate home loan rates with a human mortgage broker, but they’ll doubtless refer to your credit history. If that doesn’t hold up to scrutiny, you’re likely to get flagged by the system as a high-risk borrower. And matters are even worse for the so-called “credit invisible.” AI won’t deem these people as trustworthy.
Yet the power of AI doesn’t have to extend along a one-way street. Developers have given us access to tools that can introduce algorithms into our everyday decisions, and that can actually be an advantage towards realizing our financial goals.
Filtering through the noise
The potential for AI to help us improve is at its greatest in the area of cognitive decision-making. Humans are susceptible to bias, especially in a domain like finance, where the complexity and stakes involved are both high.
Bias is particularly pervasive in our online, highly networked world. When we struggle with money matters or seek an answer to financial questions, we tend to look things up on the internet. Yet due to bias, we’re likely to give undue importance to unreliable sources: blogs without authoritative sources or trending social media posts that merely reinforce a herd mentality.
AI can help us cut through the online noise, and the tools we need to accomplish that are often built right into the search engines we use daily.
Instead of directly inputting the question you have in mind, try to isolate keywords and phrases and use quotation marks. Professional or technical terms can also raise the visibility of scholarly sources in your query. Rather than searching ‘how to improve my finances,’ try ‘raise “financial literacy” level’ and notice how more authoritative sources turn out. Other operators or advanced search options can refine those results even further.
Analyzing risk tolerance
Bias also makes us prone to bad patterns of spending and investment. For instance, people can experience an endowment effect that raises their attachment to an item once they own it. Similarly, we can routinely fall prey to the sunk cost fallacy, making something harder to abandon when we’ve already invested in it.
These things happen because most people are naturally risk-averse. It’s a survival mechanism that evolved to bolster our ancestors’ chances of adapting and thriving in a harsh and dangerous environment. However, in modern finance, it often works to our detriment, locking us out of opportunities or failing to alert us to the dangers of clinging to financial liability.
Traditionally, your level of comfort with financial risk would be assessed through a questionnaire. An advisor would attempt to profile you as tolerant or averse, on a scale of 1-10, based on your responses. It’s a flawed approach at best because that data is merely a snapshot reflecting your mental state at that time.
Behavior must be mapped continuously, and risk management algorithms now paint a far better picture of your true preferences. Companies such as Bloomberg, Crest Financial, and SWS Partners are making this technology available to investors. By letting AI do the risk analysis, you achieve something much closer to objective decision-making in managing your portfolio.
Relying on optimistic assumptions
By far, the greatest impact AI can have on your finances, however, is in helping you adhere to a long-term plan.
The most common mistake people make is overestimating discretionary spending ability. It’s easy to justify indulging in a fancy meal or shopping spree when you paint a rosy picture of the future. You’re in line for a promotion or raise soon, or that investment you’ve been holding onto will finally appreciate.
Along these lines, we also underestimate the danger of negative events coming to pass. Getting sick, or injured in an accident, getting laid off, or losing assets to fraud, theft, or natural disaster: all of these call for the liquidity of an emergency fund.
You don’t get that flexibility without the discipline it takes to stick to a sensible budget each day. And people have trouble with discipline, which is where AI comes in. Get started with free apps like Mint or Zeta, then add steps to automate transferring funds to a savings account and settle the bills. Make do with what’s left, which is what you can truly afford to spend.
When AI can step up to support our mistake-prone brains, it could truly be the difference-maker in achieving your financial goals.