Machines threatening human beings is not a new thing. It’s been a theme of countless science fiction movies, and folk stories like John Henry vs. the Machine. It is being talked a lot today in the “modern economy” and not just as it relates to coal miners.

Tech has become a hot topic in the finance industry too. Folks are wondering what the advancement of tech and artificial intelligence means for the future of financial services and how investors manage their money.

My general opinion is that tech is and will continue to give investors better and more options at a lower cost than ever before. I think that is most evident in the shift towards independent RIA firms. Many of these firms would not have been able to exist 15 years ago, but today technology allows sole proprietor RIAs to compete with the biggest wire houses for clients. For this piece, I want to address a specific element of tech and investing. I want to look specifically at tech and portfolio management.

“Won’t portfolio managers be replaced by algorithms?” That is the question that was recently asked me, and my answer is very simple “no.”

Technology, and algorithms will enhance and make portfolio managers more efficient than ever before, but they will not replace the human element. There are two extremely important concepts that explain why.

1. The markets are a function of supply and demand.

2. The markets are discounters of widely known information.

Supply & Demand

Algorithms can be used to evaluate supply. Computers can look at all the data in the world on publicly traded companies, and all the economic data, etc., etc., but ultimately a human will need to make an interpretation of that data as it relates to demand. Demand is emotional, demand it is sentiment driven, and that makes it uniquely human. My dad once told me “that something is only worth what someone else is willing to pay for it.” His statement is 100% spot on when it comes to capital markets.

Discounter of Information

All known information is factored into the market. That means that once information is known it becomes obsolete, unless it is interpreted in a unique manner. Therefore, I could create an algorithmic formula for managing 100 client’s portfolios that works great. However, once I start using it to work with a really large pool client portfolios or I do not constantly change the formula my algorithm will become obsolete, because it is based on assumptions and interpretations that will be discounted into the market. Think about a fish that can only swim in a straight line or turn left, how long will it take the shark to figure out that the fish always turns left?

Geeks have been trying to be smarter than the markets for years, always convinced that they have what it takes and that “this time it’s different.” Success investing in capital markets will always be more dependent on the stomach than the brain, and that means humans will always have a place in portfolio management.

– Wyatt Swartz

6/21/2017

The Advisor Insights question and answers can be found on Investopedia here.

Question Headline:

How does an investor make money when entering a Futures Contract?

Question Body:

I am very new to futures and options. I have been watching videos here on Investopedia in order to learn, but have hit a bit of a snag. On the Futures Contract page, the video states at the end, that the Investor takes on both the risks and rewards by creating this contract. If the milk price goes up, the investor breaks even by gaining money from Tim’s Dairy and losing money from Al’s Ice Cream. Again, when the milk price goes down, the Investor loses money with Tim’s Diary and gains money with Al’s Ice Cream. In every situation, the investor breaks even. So why would the investor waste his time? The only one who is seeming to benefit are Tim’s Dairy and Al’s Ice Cream. What am I missing?

Answer:

When entering a futures contract, an investor is not guaranteed to break even. It is very likely that the investor will gain, or lose money in relative terms. The reason behind this is because, a futures contract obligates the people involved to abide by the contract.

For example, let’s say Joe and Dan enter into a futures contract where Joe plans to sell Dan 100 phones one year from now, for $150 per phone. However, in one year the current market price of phones is $100. Dan is obligated to pay the higher price of $150, due to the futures contract. From this particular futures contract, Joe just made a profit of $5,000 in relative terms, an extra $50 per phone.

Futures contracts can be dangerous, due to the lack of flexibility in the contract. The investor must be confident on the agreed upon price, in order receive higher profits in the future.

In general, I do not recommend the typical retail investor use futures contracts within their investment portfolios. Your average retail investor would be better served focusing on having the appropriate asset allocation (mix of stocks, bonds, and cash) based on their goals, time horizon, and cash flow needs.

— Wyatt Swartz

— Contributions by Caitlin Lammers

— 6/8/2017

A recent contribution to the Investopedia “Advisor Insights” page can be found here.

Question Headline:
Should I invest my extra income in a 401(k), a Roth IRA, or spit the investments evenly into both?

Question Body:
I will be investing 15% of $27,000 a year into a retirement fund. This money is additional income from a new job. My new job offers a 401(k) with a match of 3%. I have also heard that a Roth IRA is a good choice. Should I do 15% in one or the other, or split it half and half? What do you think?

My Response:
You should take full advantage of your company 3% match, so you should be contributing at least 3% of your extra income into your 401(k). To decide where to invest the rest of your income, you need to understand the key differences between a traditional 401(k) and a Roth IRA.

401(k) contributions are tax-deductible reducing your current taxable income and therefore reducing how much you pay in taxes today. The funds within the account grow tax-deferred meaning there are no tax consequences as long as the funds remain in the account until retirement. In retirement (after age 59 ½) distributions from the 401(k) will be taxed as ordinary income.

Roth IRA contributions are “after-tax” meaning there is no reduction in the participant’s tax liability today. Funds within the account grow tax-free, and distributions made in retirement (after age 59 1/2) are tax-free.

In conclusion, you should contribute 3% into your 401(k) account. Where to contribute retirement savings beyond the 3% is going to be based on whether you prefer “to pay more in taxes today, but never again, or reduce your taxes today and pay in the future.” I typically recommend people with a long time horizon (20+ years) to take advantage of the Roth IRA option as much as possible as long as they are eligible. Investing in capital markets over the long-term can and should provide tremendous growth of assets. It is very powerful to never pay taxes on that growth.

— Wyatt Swartz

— Contributions by Eli Perlmutter

— 5/22/2017