This article first appeared in the 2nd quarter 2018 edition of Personal Finance magazine.
Artificial intelligence is changing the face of investing and will have profound impacts on how risk is priced and investment returns are achieved as we build up the capital to meet our retirement needs – and live longer lives.
The game-changing nature of artificial intelligence (AI) became evident in chess. Thirty years ago, Garry Kasparov, the world chess champion at the time, managed to beat 32 of the most advanced chess computers simultaneously within the space of five hours. Twelve years later, in 1997, a single computer called Deep Blue famously defeated Kasparov in a heavily publicised match that Newsweek called “The brain’s last stand”.
Today, any one of the world’s leading chess computers would defeat a room filled with 32 of the world’s grand masters of the game.
More recently, in 2017, an AI computer algorithm called AlphaZero learnt to play chess in four hours and subsequently went on to beat the world’s leading chess computer. In those four hours, it learnt the rules of chess, taught itself to play and assimilated all the chess data possible. And in beating the leading computer, AlphaZero revolutionized the chess world by playing moves never seen before in the 1500-year history of chess.
These developments have powerful implications for investing, not least because medical advances are likely to further increase longevity.
AI is being used in cancer diagnosis trials, and experts say that it should be able to teach itself to read MRI and CAT scans more quickly and accurately than doctors. This is incredibly exciting for the treatment of cancer. AI is, in fact, being used throughout the medical world to provide us with better quality lives and, importantly, longer lives.
From an investment perspective, this means that our savings will need to be stretched over a longer period to meet our future cost of living. We refer to this future cost of living as a “liability”.
As we expect to live longer, our liability increases - in other words, we need more capital now to fund our cost of living in the future. For example, a 65-year-old expected to live 20 years and requiring R20 000 a month to live adequately, would require capital of about R3.7m. If the individual is expected to live an additional 10 years, the capital required increases to about R5m. This represents an increase of roughly 35% in the capital required to live adequately.
The question is, can AI be used to boost your savings to ensure that you have enough to last for your entire lifetime, especially if you are likely to live longer?
In answering this question, let’s consider how AI is currently being used in the investment industry:
Chatbots: which are programs designed to converse with humans, engage with customers and provide answers in a manner similar to Apple’s Siri.
Robo-advice: provides financial advice with little or no human intervention. There has been a lot written about this.
Fraud detection: by analysing patterns of consumer spending, AI can set a behavioral baseline against which it will quickly compare and score a new transaction, thereby performing early fraud detection.
Underwriting: wearable devices such as smartwatches and fitness trackers provide real-time insight into policyholder behavior. This real-time data is fed into an AI system to understand and even predict policyholder health.
Investment analysis: collect and assimilate annual financial statements, analyst reports, JSE announcements, media statements etc. to make efficient, real-time investment decisions.
While the verdict is still out on AI’s effectiveness, the aim of these engagements is to enhance customer experiences, offer more accurate pricing of risk and ultimately generate better investment returns for investors. However, while these applications are highly innovative, they are unlikely to meaningfully boost the capital required to meet the increased liability associated with a rise in life expectancy.
So what can be done?
Better match your future liabilities
Employ a liability-driven investment (LDI) framework so that, as the name suggests, your future financial obligations drive your investment strategy. This includes, among other things, investing in assets that provide inflation-linked returns such as infrastructure, property and renewable energy, as these are likely to provide a better match for your future liabilities (which themselves are likely to increase with inflation) without excessive capital volatility.
This is important because if you experience negative returns, then you have to earn even higher returns to get back to where you started. For example, if I have R100 and lose 10% of my investment (say over one year) then I need to earn 11.1% the next year to get back to my original R100.
This is even more difficult if you are drawing an income from your capital base. Extending the example further, if I lose 10% over one year and also have to pay living expenses of R5 over the year, then I will need to earn 17.6% the next year to get back to my original R100.
Consider deferring current spending in favour of funding your future cost of living and meeting your future liabilities, to the extent possible. Key to this is drawing up a personal budget and understanding how it is likely to evolve with age and how it may change in the case of a life-changing event.
In a country like South Africa with a significant skills shortage, individuals with life and work experience have immense value to provide to the country by transferring their knowledge to the younger generation via formal training and mentorship programs. The government could play a role here too and reward educators with tax rebates on their retirement income.
Invest with AI-savvy asset managers
Employ investment managers that embrace AI. Combining human intelligence and AI is likely to lead to a better outcome than only using human intelligence or only using AI. The ultimate success of combining human intelligence and AI, however, depends on the process employed.
Keep an eye out for innovative longevity products
Financial services providers could develop products such as longevity swaps and reverse mortgages. Longevity swaps reward investors if they live past their life expectation. Reverse mortgages release the equity built up in individual’s homes by paying them an income while they are alive, with the financial services provider being reimbursed from the proceeds of the sale of the home on the death of the individual (or his/her spouse, if later).
While these ideas may not be ground-breaking, adopting any one – or all – of them may keep your investment plan on track to avoid checkmate and give you the best chance to comfortably afford retirement.
Trevor Abromowitz is the head of Old Mutual Investment Group’s Liability Driven Investments boutique.