In the first installment of my three-part series, we explored the history and risks of artificial intelligence (AI), especially around your finances. In the second installment, we explored the limitations of AI regarding your investments.
The ability of chatbots to produce sensical, natural language responses to human prompts is remarkable. This had me wondering whether chatbots can truly offer quality, personalized financial advice?
It was time for me to enter the ring and go head to head with AI on financial planning questions. Let’s find out how it did.
Putting AI to the Financial Intelligence Test
In my curiosity, I decided to test two well-regarded language model AIs – Chat GPT (Open AI) and Claude (Anthropic) – to see how they would respond to a common financial planning question. The same question was posed to each AI.
We’ll begin by reading each AI’s response to the question, then I’ll break down each point it generated and provide my critique.
First Up: Financial Advisor vs. Chat GPT-4
Question: What is the right asset allocation for a 65-year-old retired couple?
Chat GPT: “Determining the right asset allocation depends on various factors, and it is not solely based on the individual’s age. For a 65-year-old retired couple, these factors might include their risk tolerance, financial goals, retirement savings, income sources, and life expectancy.
- Risk Tolerance: This refers to the degree of variability in investment returns that an individual is willing to withstand. As individuals age, they tend to become more risk-averse and thus may prefer a more conservative asset allocation.
- Financial Goals: If the retired couple has specific goals in mind, like leaving a significant inheritance or donating to charity, then they may require a different allocation compared to a couple who’s mainly focused on funding their lifestyle.
- Retirement Savings: The amount of money the couple has saved for retirement is also crucial. If they have substantial savings, they may be more comfortable taking on some risk in their portfolio.
- Income Sources: A couple with significant guaranteed income sources (like Social Security, pensions, etc.) might be able to take on more risk compared to those who are heavily reliant on their investments for income.
- Life Expectancy: Longer life expectancy can influence the couple to maintain a certain portion of their portfolio in growth-oriented assets like equities.
That being said, a common rule of thumb is the “100 minus age” rule, which suggests that you should subtract your age from 100 to determine how much of your portfolio should be invested in stocks, with the remainder in bonds and other relatively safe assets. For a 65-year-old couple, this would mean 35% in stocks and 65% in bonds.
However, some financial advisors feel this rule might be too conservative given increased life expectancies and lower interest rates, leading some to recommend the “110 or 120 minus age” rule. This would put a 65-year-old couple at 45-55% stocks, with the remainder in bonds and other assets.
These are all general strategies and each person’s situation may require a different approach. It is always best to consult with a financial advisor who can provide personalized advice based on the couple’s unique situation and goals.”
My Breakdown of Chat GPT’s Response
ChatGPT gave us a lengthy answer that is worth exploring in depth. To help determine the reliability of the information given and put it in context, here is my assessment of the points Chat GPT made with regards to my original prompt:
Chat GPT: “Determining the right asset allocation depends on various factors, and it is not solely based on the individual’s age. For a 65-year-old retired couple, these factors might include their risk tolerance, financial goals, retirement savings, income sources, and life expectancy.”
Ok AI, this is a good start. It’s true but vague and not at all actionable. Still, let’s continue to review the breakdown.
Chat GPT: “1. Risk Tolerance: This refers to the degree of variability in investment returns that an individual is willing to withstand. As individuals age, they tend to become more risk-averse and thus may prefer a more conservative asset allocation.”
Sure, but this misses the idea that being too conservative or too aggressive may place financial goals beyond reach. A portfolio that is too conservative may not produce the growth necessary to achieve one’s goals. A portfolio that is too aggressive may be vulnerable to large losses from which an investor won’t have time to recover. Risk tolerance is nuanced and this assessment is a broad generalization. Age certainly plays a role, but so do your life plans and past experiences.
Chat GPT: “2. Financial Goals: If the retired couple has specific goals in mind, like leaving a significant inheritance or donating to charity, then they may require a different allocation compared to a couple who’s mainly focused on funding their lifestyle.”
Yes, goals always need to be considered. Thanks for letting us know.
Chat GPT: “3. Retirement Savings: The amount of money the couple has saved for retirement is also crucial. If they have substantial savings, they may be more comfortable taking on some risk in their portfolio.”
This borders on being wrong. If an investor has substantial savings, they may not need to generate high returns to meet their goals. If an investor’s assets are limited, taking on more risk might be the only path to achieving their retirement goals. Here, the AI is reflecting common misperceptions. This is exactly why you still want to engage in a nuanced conversation with a financial advisor.
Chat GPT: “4. Income Sources: A couple with significant guaranteed income sources (like Social Security, pensions, etc.) might be able to take on more risk compared to those who are heavily reliant on their investments for income.”
This also borders on being wrong. Having a pension could remove the need to take more risk as well as creating space for more risk taking. This dynamic is very particular and best explored in consultation with an advisor.
Chat GPT: “5. Life Expectancy: Longer life expectancy can influence the couple to maintain a certain portion of their portfolio in growth-oriented assets like equities.”
What does one do with this observation? Let’s say that the life expectancy of a 65-year-old male is 82. Should that person only plan to live to 82? Absolutely not! 50% of people will live longer than the average. At Abacus, we assume everyone will live until age 96 unless your health history suggests otherwise. There is a 47% chance that one member of a couple will live to age 90. And since you can’t know when you might pass away, you must allow for the possibility of longevity.
Chat GPT: “That being said, a common rule of thumb is the “100 minus age” rule, which suggests that you should subtract your age from 100 to determine how much of your portfolio should be invested in stocks, with the remainder in bonds and other relatively safe assets. For a 65-year-old couple, this would mean 35% in stocks and 65% in bonds.”
Actually, the common (though generalized) allocation for a 65-year-old retired couple is 60% stocks and 40% bonds. Also remember, asset allocation depends on an individual’s unique goals, needs, and financial situation. The AI generated 35/65 allocation results in a 3.3% lower sustainable income and a 14.1% lower inheritance for heirs. Most significantly, it greatly limits the opportunity for an upside surprise. AI is amplifying a common misperception that has been largely rejected among financial professionals.
Chat GPT: “However, some financial advisors feel this rule might be too conservative given increased life expectancies and lower interest rates, leading some to recommend the “110 or 120 minus age” rule. This would put a 65-year-old couple at 45-55% stocks, with the remainder in bonds and other assets.”
At the time of this writing, Chat GPTs knowledge stops in September of 2022. Interest rates are no longer low. More importantly, an asset allocation should not shift in response to changing interest rates, in my humble opinion.
Chat GPT: “These are all general strategies and each person’s situation may require a different approach. It is always best to consult with a financial advisor who can provide personalized advice based on the couple’s unique situation and goals.”
Yes, consult with a financial advisor! And I would add, in your search for a financial advisor, to consider working with a fee-only, fiduciary, CERTIFIED FINANCIAL PLANNER™. This one I endorse without reservation.
Next Up: Claude AI vs. a Financial Advisor for Retirement Advice
Question: What is the right asset allocation for a 65-year-old retired couple?
Claude: Here are a few tips for determining asset allocation for a 65-year-old retired couple:
- At age 65, it’s common to shift towards a more conservative asset allocation that has lower risk and volatility. This helps protect the nest egg as retirement continues.
- A moderate allocation might be 60% bonds/fixed income, 40% equities. This provides some growth potential from stocks while also providing stable income from bonds.
- Another option is an allocation like 50% bonds, 30% stocks, 20% cash/short-term. This further reduces volatility.
- Within equities, emphasize dividend paying stocks and avoid high-growth sectors like technology. Focus on stable large-cap companies.
- Make sure to have 2-3 years of living expenses in safe cash-equivalents to cover near-term withdrawals without selling assets in a down market.
- Hold some of the fixed income portion in CD ladders to take advantage of rising interest rates as shorter-term CDs mature.
- Rebalance portfolio back to target allocations at least once a year.
- As health needs increase in very advanced age, consider shifting more to cash to cover expenses.
The exact allocation depends on risk tolerance and income needs. A financial advisor can help fine-tune the percentages, but a balance of stocks and conservative fixed income is prudent for 65 year old retirees. Let me know if you need any clarification or have additional questions!
My Assessment of Claude’s Response
To again help determine the reliability of the information given and put it in context, here is my assessment of the points Claude made with regards to my prompt:
Claude: At age 65, it’s common to shift towards a more conservative asset allocation that has lower risk and volatility. This helps protect the nest egg as retirement continues.
This is typically true but this information is not actionable. Should this hypothetical couple wait until retirement to shift their portfolio towards a more conservative allocation, or do it sooner? At Abacus, our annual client reviews diagnose whether your goals could be achieved with less risk taken in the portfolio. Asset allocation is a conversation at every age.
Claude: A moderate allocation might be 60% bonds/fixed income, 40% equities. This provides some growth potential from stocks while also providing stable income from bonds.
Like GPT, Claude is suggesting a portfolio that a financial advisor may regard as too conservative for your particular situation. Too little growth potential can leave you exposed to inflation and with inadequate growth to achieve your objectives.
Claude: Another option is an allocation like 50% bonds, 30% stocks, 20% cash/short-term. This further reduces volatility.
Whoa, this is even more conservative! It results in an 8.8% reduction in sustainable income and a 16% lower inheritance for heirs versus a 60/40 allocation. Knowing the specifics of a person’s financial situation is crucial as it allows a financial advisor to work with clients to fine-tune their investment allocation to their needs and goals.
Claude: Within equities, emphasize dividend paying stocks and avoid high-growth sectors like technology. Focus on stable large-cap companies.
Sorry Claude, I’m going to have to put my foot down and disagree with you here. At Abacus, we employ a more diversified approach, backed by research, that reduces risk and increases expected returns compared to this recommendation. See my recent blog Should I Be Investing for Dividends to explore why.
Claude: Make sure to have 2-3 years of living expenses in safe cash-equivalents to cover near-term withdrawals without selling assets in a down market.
That is decent advice but may be too conservative for some. Again, it depends on the person’s situation. As your advisor, I would carefully measure whether taking this recommendation would undermine the viability of your retirement plan. I’d ask if you have flexibility in the timing of major expenses, or see about accessing a line of credit in down markets, or selling bonds while waiting for stocks to recover.
Claude: Hold some of the fixed income portion in CD ladders to take advantage of rising interest rates as shorter-term CDs mature.
I tend to not recommend CDs. We believe there are better options to explore.
Claude: Rebalance portfolio back to target allocations at least once a year.
Rebalancing is decent (if overly obvious) advice. At Abacus, we review your allocation often but trade rarely. By checking portfolios twice a week, we are more likely to sell what is up and buy what is down than if we only check annually or quarterly. This can both enhance returns and lower risk. And it does not result in excessive or even frequent trading.
Claude: As health needs increase in very advanced age, consider shifting more to cash to cover expenses.
That is decent advice if, again, quite general.
Claude: The exact allocation depends on risk tolerance and income needs. A financial advisor can help fine-tune the percentages, but a balance of stocks and conservative fixed income is prudent for 65 year old retirees. Let me know if you need any clarification or have additional questions!
Good for you Claude. You also recommended that a financial advisor can help.
Conclusions about AI’s Financial Advice
Chatbots are decent at furnishing context to further explore questions, financial or otherwise. But AIs don’t have your financial specifics – and that is the critical piece to producing quality financial advice from anyone, AI or human.
Remember, Chat GPT and Claude are large language models. By observing vast stretches of the internet, chatbots learn to predict the most likely next word and may only provide answers that sound correct. Chatbots are not engaging in logic or reasoning. It’s important to note that they can also produce patently false recommendations.
This is where we are today and I will continue to keep an open mind. For now, Chatbots are much more an indication of AI’s potential than a productivity tool that is ready for professional primetime.
I am incredibly excited for the efficiencies that it may bring to my writing, for how it may help firms like Abacus better access their internal knowledge base and automate certain mundane tasks. I imagine that many of the information tools and services will find ways to embed AI to increase productivity.
For genuine, thoughtful, and specific advice regarding your personal financial planning situation, reach out and schedule a call with Abacus today. Let us help you expand what is possible with money, with human intelligence and experience.
Disclosures:
Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Abacus account holdings correspond directly to any comparative indices or categories.
Please Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Abacus accounts; and, (3) a description of each comparative benchmark/index is available upon request.
