It’s only a matter of time before a story with that headline, or something like it, appears in the financial press. Recent stories in the news indicate that elite investment professionals have purportedly had astounding success in trading securities for short-term profits by using artificial intelligence (AI) programs to chart the course of investments. This may well be the future, because computers can do everything faster than human brains.
Somewhere, in his parents’ basement, the next Sam Bankman-Fried — let’s call him Biff, after the blowhard from the movie Back to the Future* — is using an AI program to determine which securities to buy and when to buy and sell them. He founded Biff’s Investment Management, and he’s making money hand over fist, not just for himself, but for his very happy clients. Until he doesn’t. It could be that Biff’s AI program wasn’t as foolproof as he thought. It could be that Biff’s finger slipped, and he shorted a lot more stock than his AI program told him to sell. It could be that a disgruntled troll in Biff’s back office just made a series of blunders.
Biff is a fraud
Or, as I hereby predict, Biff doesn’t have an AI program at all. The trades were never made. The profits never existed. The reports to his clients were a series of postdated fabrications. Does this sound familiar? It should. Just substitute “Bernie Madoff” for “Biff.”
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Madoff made his customers believe him by inventing a nonexistent trading strategy that purportedly beat the stock markets. Every. Single. Month. But he never made any investments at all. How did he fool his clients? Toward the end of every month, his staff of collaborators would pick a few stocks that had actually risen in value that month, backdated fictional purchase confirmations for trades that had never been made at the beginning of the month and equally fictional sale confirmations for the end of the month. Customers got statements showing those fictional monthly gains.
Instead of investing his clients’ money, Madoff funded a lavish lifestyle for his family and used later investor cash to pay off any customer who chose to withdraw money. It was the biggest Ponzi scheme in history.
Biff will tell his clients that his AI program has been tested by millions of hypothetical trading scenarios and is 97% profitable. (A 100% success would sound too much like an election result in a dictatorship.) And of course, Biff can’t share the details of how the program works this magic, because everyone would use it and would break the concept. In other words, he will simply modernize Madoff’s cover story.
What can you do to minimize risk?
AI investment advice is a new application of a very new technology, with all the risks that entails. You should not put all your financial eggs in this basket. If you do believe that there is merit to the concept that an AI program may in fact beat the market, how can you minimize the possibility that a bad actor like Biff misappropriates your cash and securities?
- As we all know from reading our collection of Spider-Man stories, Uncle Ben told Peter Parker that “with great power comes great responsibility.”** The Biffs of the world will never get that message. It falls to you to take as many precautions as you can to avoid the possibility that your assets are misused. Regardless of where you get your investment advice, make sure that your cash and securities are in the custody of a broker-dealer registered as such with the SEC and is a member of the Securities Investor Protection Corp. (SIPC). Your periodic statements from a registered broker-dealer will reflect exactly what cash and securities positions are being held for your account. Monitor those periodic statements closely. In a world where monthly statements or quarterly statements are distributed electronically, rather than mailed, it is easy to ignore them. Further, this is not a foolproof system: Madoff deceived both regulators and investors for decades. While his investors did not receive the fictional profits they thought they had earned, Madoff’s victims did receive the net amount they deposited with him.
- Identify any disparities in your brokerage firm statements from what you understand your holdings to be. Do this in writing. Remember this: Phone calls are worth the paper they are written on. If you do speak about your account with anyone, confirm the details of that conversation in writing. With email at your fingertips, there is no excuse for not having a written record of any issues.
- If you have difficulty reaching any investment professional, contact the SEC and your state’s securities commissioner immediately.
* Biff figured most prominently in the 1989 movie Back to the Future Part II, in which he used a sports almanac from the future to place bets on upcoming games.
** In particular, Marvel’s Amazing Fantasy #15, August, 1962.
Related Content
- Beyond the Hype: A Guide to Investing in AI
- Can Stocks Picked by Artificial Intelligence Beat the Market? 3 Stocks to Watch
- How AI Can Help Take the Emotion Out of Investor Decisions
- AI Has Powerful Potential to Make Investing Decisions Easier
- Don’t Hand Your Retirement Income Planning Over to AI Just Yet
-
Time to Spring-Clean Your Finances: A Financial Professional's Four Steps to Tidy Them UpA midyear review of everything from spending to saving, with adjustments as needed, can set you on track to financial security. Plus, don't forget to check in on your workplace benefits.
-
Why a Law Firm Secretly Recording Client Conversations Is Wrong (and Illegal)A law firm that has been recording client conversations without the clients' knowledge or permission and has threatened employees if they speak out faces legal and ethical challenges.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
