09/14/2001

New Way to Beat the Street

The last 18 months have been very depressing for stock investors. Certainly, like all market downturns, it will not last and eventually portfolios will improve. However, if there were a system you could have employed to better manage your money during these hard times, wouldn't you be interested? Let me introduce you to artificial intelligence. Yes, artificial intelligence could be impacting your portfolio soon and it just may be the investment edge you are looking for. In this article, we will explore this brave new world and explain how you might use it to your advantage.

Background

Some brokerage companies are turning to artificial intelligence or artificial neural networks to gain a market edge. An artificial neural network is simply a computer system that makes forecasts or decisions based on past data. Such systems can actually simulate the processes of the human brain. Furthermore, the system can go a step further than the human brain because this type of system can process huge volumes of information at lightning speeds.

Artificial neural networks like the human brain learn by observing patterns. Neural Network systems actually review thousands of pieces of data and then it can identify patterns, assess causal relationships, and then make interpretations. Such a system is fed a variety of market and economic data including stock market indices, new highs and lows, advance decline indicators, interest rates, energy prices, etc. The data is used to test and train the network. The system can then be very adaptive - as it learns. It adjusts to the changing world, will discard assumptions that prove invalid, retests hypotheses, and arrives at new conclusions of how the economic data will affect your portfolio.

Compare

Now compare this system with your current portfolio. Most portfolios are managed on a "static" basis. On average a group of mutual funds and stocks are selected and then adjusted on an annual or semi-annual (maybe quarterly) basis by you or your advisor. The adjustments are often made in hindsight, on less than comprehensive information, and frequently after the market has corrected. Certainly, as long as you have a diversified asset, sector and style mix, your portfolio will do OK, over the long run.

The alternative is the portfolio subjected to the neural network system. This portfolio is essentially monitored every day! It is also a system making predictive judgments about future market conditions, not just responding to past events. The judgments are also made on a plethora of economic and market data that no human being or pc system could factor-in. >p> The result is active portfolio management! Your assets are reviewed on a continuous basis and changes are made accordingly. Ultimately you get a thorough, incomparable and daily portfolio management system.

Now as good as this sounds, and it is an impressive portfolio management system, it does not mean you will avoid losses. This system, like no one individual, cannot predict the market with 100% accuracy. However, the goal is that this type of active portfolio management will do better than other approaches.

Process

Active portfolio management by artificial intelligence systems yields itself to frequent rebalancing of your account. Thus, most companies only offer this option for retirement accounts - IRA, Roth's, Rollovers, 401k's, etc. Why? Simple -- the portfolio changes do not generate tax consequences. If such a system were employed into a non-qualified account, each portfolio change could create additional tax consequences.

Although every system is different, it is common that such programs manage "pre-packaged" portfolios. Many of the funds you have may be in the system, but probably not all. The goal is to pick the portfolios that most closely matches you time horizon and your risk tolerance.

Costs

Naturally, costs vary. However, rest assured that there would be an additional charge for this service. On average you should probably expect to pay between 1.5% to 2.5% annually. Some firms offer "break points" on the charges. In other words, the more money you invest that is managed this way, the lower your annual fee.

Summary

Some of these systems have actually been up and running in the investment community and have actual investment track record. Based on the returns I have seen, this approach to investing is very attractive. While it is not a fail-safe approach, it looks to be a truly promising investment edge.

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Please send questions or comments to dcoffin46333@wradvisors.com.