How Is AI Impacting the World of Investing?

Artificial intelligence (AI) technology is transforming multiple industries, including the financial services sector. Fintech companies, financial advisors, and wealth management firms are some of the entities that are starting to utilize AI for investing, by capitalizing on AI’s power to streamline compliance processes, automate trades, detect fraud, anticipate market patterns, and much more.

That said, the role of AI in investing is still being defined, and there are numerous questions about what this technology can and can’t do. You may be wondering where artificial intelligence fits into your portfolio and decision-making, or if it should at all. Another concern is how transparent financial institutions should be when incorporating AI into their products and processes.

Using AI to invest may offer possibilities, but it also comes with potential risks. Here’s a closer look at how AI is impacting the world of investing.

The Evolution of AI in Financial Markets

AI technology’s core concepts — including the use of algorithms and automation — have been at work behind the scenes in financial markets for decades. After some initial ups and downs in the 1980s, interest in AI saw a resurgence in the 1990s and an eventual expansion into machine learning, data mining, virtual reality, and case-based reasoning.

Deep learning, which harnesses artificial neural networks to solve problems and analyze vast stores of data, emerged in 2011, and investment firms began experimenting with AI-powered, algorithm-based trades. In 2018, BlackRock announced that it would create an AI lab, with the firm’s plans focused on incorporating machine learning into its asset management strategies.

How popular is AI among financial advisors? A 2024 report from Mercer found that 91% of investment managers were either using or planned to use AI within their investment strategy or for asset class research. Just 9% of managers surveyed said they had no plans to use AI, suggesting that artificial intelligence may be poised for widespread adoption in the not-too-distant future.

Key AI Technologies Transforming Investment Strategies

AI is an umbrella term that encompasses a number of different technologies that financial firms utilize in various ways. Here are some of the tools advisors and wealth managers are leveraging to incorporate AI in investing, and which may come into play when investing online.

Machine Learning Algorithms and Predictive Analytics

Machine learning (ML) refers to how computers “learn” from analyzing large swaths of data without being specifically programmed to do so. ML tools absorb data, analyze it, and draw conclusions from it to solve problems.

In financial services, machine learning’s uses include:

Robo investing services, or robo advisors, are a prime example of AI portfolio management at work. Many robo advisors rely on ML-driven algorithms to analyze client portfolios and make predictive investment recommendations.

It’s not just robo advisor platforms that are using machine learning to drive investment decision-making. In 2023, for example, Morgan Stanley announced that it would partner with OpenAI, a machine learning research and deployment company, to develop an analytics tool that would help the firm’s advisors better assist their clients.

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Natural Language Processing for Market Sentiment

Natural language processing (NLP) uses machine learning to help computers understand human language and communicate with it. NLP was the precursor to generative AI, which is equipped to create images, video, and audio content based on prompts.

Financial firms use natural language processing for sentiment analysis, which involves analyzing text to determine the sentiment or emotion being expressed — for example, around how to invest in stocks. Sentiment analysis is frequently used in marketing to gauge how consumers will react to specific messaging, but it also has implications for investing.

NLP-driven algorithms use sentiment analysis to review news articles, social media content, blog posts, and other text documents and identify whether the thoughts, emotions, and opinions expressed in them are positive, negative, or neutral. Financial advisors and wealth managers can then use the results to make trading decisions based on the mood of the market.

AI-Driven Investment Tools and Platforms

Investment tools and platforms can simplify the process of building and managing a portfolio, and you may be using them without even realizing it. Here are some examples of where you may encounter AI investing tools.

Brokerages and robo-advisors can infuse one or all of these tools into their platforms for the benefit of investors. They may partner with third-party AI platforms or develop their own proprietary AI models and tools to offer to their customers.

Algorithmic Trading and Automated Portfolio Management

Algorithmic trading, or algo trading for short, is not a new idea. Algo trading is a strategy in which trades are automated, based on a predetermined algorithm. The algorithm’s parameters can be adjusted to direct trading activity using an “if X happens, then Y should happen” approach.

In terms of the role of AI in investment management, artificial intelligence makes algo trading faster and more efficient. Machine learning and predictive analytics allow AI to look at the entire market and pick out trends that may not be as quickly or easily spotted by a human advisor. Those trends would then drive buy/sell decisions.

AI can be particularly helpful for high-frequency trading (HFT), which should be on your list of investing terms to know. High-frequency trading is when numerous trades are made within a tight window to take advantage of pricing fluctuations and market movements. The idea behind using AI for algorithmic trading is to capitalize on its faster data collection and processing speeds to turn profits that might otherwise be missed.

Recommended: Generative AI in Banking

Adapting Your Investment Strategy for the AI Era

The two main avenues for exploring artificial intelligence technologies are 1. investing in AI-focused securities and 2. using AI-based tools to help you invest. If you’re interested in testing the waters with AI, here are some of the ways you might use it to invest:

Consider AI-Based Investments

You can add AI-focused stocks, bonds, mutual funds, or exchange-traded funds (ETFs) to your portfolio. Using mutual funds or ETFs provides a low-cost way to access a range of securities that provide exposure to this growing sector — with potentially less risk than investing in AI stocks individually.

Use AI Tools to Do Research

Artificial intelligence is a huge field, and it’s growing rapidly. You may want to employ AI tools like ChatGPT or Claude to help you learn more about the aspects of AI that you want to invest in, whether that’s robotics, medical technology, personal assistants, or some other area.

Explore Robo Advisor Platforms

As noted above, robo platforms are a straightforward way to see artificial intelligence in action in an investing context. Here, the AI technology is used to translate personal inputs into portfolio recommendations, which are then managed algorithmically over time to stay within the preferred allocation.

One thing to keep in mind is that robo advisor fees vary considerably from platform to platform. Just as mutual funds charge an annual fee, so do these services. Make sure you understand the terms.

Caveats About Investing in AI

Setting specific investing goals about what you hope to accomplish with AI can help you narrow your focus to the right tools or platforms. Research how the tool or platform operates using AI, what you’ll pay to use it, and its associated risks or biases.

Keep in mind that at this stage, many AI investments are speculative. Financial experts typically recommend that you limit your portfolio’s exposure to speculative investments, as they often carry greater risk. Consider how much your portfolio you’d be comfortable losing when deciding how much to invest in AI strategies.

How AI is Changing Traditional Investment Roles

As AI investment trends continue to gain ground, it’s led financial services experts to question whether it will one day render human advisors obsolete. While financial advisors are unlikely to disappear any time soon, they face increasing pressure to adopt AI tools in their practices in order to remain competitive.

Some of the ways advisors are embracing AI include:

AI is and will likely continue to reshape the way the financial services industry functions. However, AI’s capabilities aren’t a replacement for the human touch that an advisor can bring — which is an important consideration when you choose an advisor. For example, if you’re tempted to sell during periods of increased volatility, an advisor can hold your hand, literally or figuratively, and provide reassurance until your panic subsides.

Risks and Limitations of AI-Based Investment Systems

While AI can offer some advantages, investors shouldn’t overlook the risks. First and foremost is the evolving regulatory landscape.

Financial advisors and investment firms are expected to uphold compliance standards when using AI, but there is still room for regulation to be expanded to protect consumers. The Securities and Exchange Commission (SEC) has identified several areas of potential concern surrounding AI’s implementation in wealth management, including:

For some investors, the risks of AI may far outweigh any perceived or actual benefits. If you’re considering AI-based investing strategies, carefully know the potential risks to your portfolio and your overall financial plan. If an AI investing tool gets it wrong and you end up with a loss, you may have very little recourse to repair the damage.

Remember that AI is not a substitute for your own judgment, or the advice of a financial advisor. An advisor can walk you through the pros and cons of using artificial intelligence to make investment decisions. They can offer advice on how to strategically implement AI into your financial plan to balance risk and reward. Consider adding a chat with an advisor to your investing checklist.

The Takeaway

Artificial intelligence investment trends continue to make headlines, and it’s natural to wonder if it’s something you should be exploring. While AI seems to be everywhere, it remains an evolving technology. At the end of the day, these tools may lead to greater efficiencies in some ways, but they cannot predict investment outcomes with 100% accuracy or guarantee returns.

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FAQ

How are investment firms using AI to gain a competitive edge?

Investment firms are using AI in different ways, from investment analysis to portfolio management. They’re also using them to develop marketing plans to attract new clients, ensure compliance with regulatory guidelines, and identify risk threats at the organizational level.

Can AI help individual investors compete with large financial institutions?

AI is opening up new horizons for investors who want to play a more hands-on role in building a portfolio. Artificial intelligence tools can help to level the playing field for individual investors to a degree, but they can’t guarantee that you’ll see the same returns as a big brokerage or wealth management firm.

What are the potential risks of relying on AI for investment decisions?

AI carries certain risks for investors, including the potential for bias to drive incorrect predictions. Remember, AI technology is still evolving. If an AI tool uses flawed data to make investment recommendations, that could drive losses in a portfolio, rather than gains. A lack of transparency, and vulnerability to cyberattacks, also increase the risk for investors who rely on AI.

How do I evaluate the effectiveness of AI-powered investment platforms?

Evaluating the effectiveness of AI-powered investment platforms begins with understanding what they’re capable of, and where those capabilities end. Overlooking the limitations of a particular platform or tool can lead to disappointing results or increased risk. Look for platforms or tools that offer a demo so you can test out the features before you commit to using it.

Will human financial advisors become obsolete with advancements in AI?

Advisors may use AI to enhance the services they offer to clients and streamline their businesses, but artificial intelligence isn’t likely to replace them completely, at least for the time being. A human advisor may be better able to address unique personal situations, and help people over time.

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