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The rise of the financial machines

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The rise of the financial machines

THE JOB of capital markets is to process information so that savings flow to the best projects and firms. That makes high finance sound simple; in reality it is dynamic and intoxicating. It reflects a changing world. Today’s markets, for instance, are grappling with a trade war and low interest rates. But it also reflects changes within finance, which constantly reinvents itself in a perpetual struggle to gain a competitive edge. As our Briefing reports, the latest revolution is in full swing. Machines are taking control of investing—not just the humdrum buying and selling of securities, but also the commanding heights of monitoring the economy and allocating capital.

Funds run by computers that follow rules set by humans account for 35% of America’s stockmarket, 60% of institutional equity assets and 60% of trading activity. New artificial-intelligence programs are also writing their own investing rules, in ways their human masters only partly understand. Industries from pizza-delivery to Hollywood are being changed by technology, but finance is unique because it can exert voting power over firms, redistribute wealth and cause mayhem in the economy.

Because it deals in huge sums, finance has always had the cash to adopt breakthroughs early. The first transatlantic cable, completed in 1866, carried cotton prices between Liverpool and New York. Wall Street analysts were early devotees of spreadsheet software, such as Excel, in the 1980s. Since then, computers have conquered swathes of the financial industry. First to go was the chore of “executing” buy and sell orders. Visit a trading floor today and you will hear the hum of servers, not the roar of traders. High-frequency trading exploits tiny differences in the prices of similar securities, using a barrage of transactions.

In the past decade computers have graduated to running portfolios. Exchange-traded funds (ETFs) and mutual funds automatically track indices of shares and bonds. Last month these vehicles had $4.3trn invested in American equities, exceeding the sums actively run by humans for the first time. A strategy known as smart-beta isolates a statistical characteristic—volatility, say—and loads up on securities that exhibit it. An elite of quantitative hedge funds, most of them on America’s east coast, uses complex black-box mathematics to invest some $1trn. As machines prove themselves in equities and derivatives, they are growing in debt markets, too.

All the while, computers are gaining autonomy. Software programs using AI devise their own strategies without needing human guidance. Some hedgefunders are sceptical about AI but, as processing power grows, so do its abilities. And consider the flow of information, the lifeblood of markets. Human fund managers read reports and meet firms under strict insider-trading and disclosure laws. These are designed to control what is in the public domain and ensure everyone has equal access to it. Now an almost infinite supply of new data and processing power is creating novel ways to assess investments. For example, some funds try to use satellites to track retailers’ car parks, and scrape inflation data from e-commerce sites. Eventually they could have fresher information about firms than even their boards do.

Until now the rise of computers has democratised finance by cutting costs. A typical ETF charges 0.1% a year, compared with perhaps 1% for an active fund. You can buy ETFs on your phone. An ongoing price war means the cost of trading has collapsed, and markets are usually more liquid than ever before. Especially when the returns on most investments are as low as today’s, it all adds up. Yet the emerging era of machine-dominated finance raises worries, any of which could imperil these benefits.

One is financial stability. Seasoned investors complain that computers can distort asset prices, as lots of algorithms chase securities with a given characteristic and then suddenly ditch them. Regulators worry that liquidity evaporates as markets fall. These claims can be overdone—humans are perfectly capable of causing carnage on their own, and computers can help manage risk. Nonetheless, a series of “flash-crashes” and spooky incidents have occurred, including a disruption in ETF prices in 2010, a crash in sterling in October 2016 and a slump in debt prices in December last year. These dislocations might become more severe and frequent as computers become more powerful.

Another worry is how computerised finance could concentrate wealth. Because performance rests more on processing power and data, those with clout could make a disproportionate amount of money. Quant investors argue that any edge they have is soon competed away. However, some funds are paying to secure exclusive rights to data. Imagine, for example, if Amazon (whose boss, Jeff Bezos, used to work for a quant fund) started trading using its proprietary information on e-commerce, or JPMorgan Chase used its internal data on credit-card flows to trade the Treasury bond market. These kinds of hypothetical conflicts could soon become real.

A final concern is corporate governance. For decades company boards have been voted in and out of office by fund managers on behalf of their clients. What if those shares are run by computers that are agnostic, or worse, have been programmed to pursue a narrow objective such as getting firms to pay a dividend at all costs? Of course humans could override this. For example, BlackRock, the biggest ETF firm, gives firms guidance on strategy and environmental policy. But that raises its own problem: if assets flow to a few big fund managers with economies of scale, they will have disproportionate voting power over the economy.

Hey Siri, can you invest my life savings?

The greatest innovations in finance are unstoppable, but often lead to crises as they find their feet. In the 18th century the joint-stock company created bubbles, before going on to make large-scale business possible in the 19th century. Securitisation caused the subprime debacle, but is today an important tool for laying off risk. The broad principles of market regulation are eternal: equal treatment of all customers, equal access to information and the promotion of competition. However, the computing revolution looks as if it will make today’s rules look horribly out of date. Human investors are about to discover that they are no longer the smartest guys in the room. ■

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How Uber Got Lost

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How Uber Got Lost

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Gutting the IRS

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Gutting the IRS

ProPublica is a nonprofit newsroom that investigates abuses of power. Sign up for ProPublica’s Big Story newsletter to receive stories like this one in your inbox as soon as they are published.

The IRS audits the working poor at about the same rate as the wealthiest 1%. Now, in response to questions from a U.S. senator, the IRS has acknowledged that’s true but professes it can’t change anything unless it is given more money.

ProPublica reported the disproportionate audit focus on lower-income families in April. Lawmakers confronted IRS Commissioner Charles Rettig about the emphasis, citing our stories, and Sen. Ron Wyden, D-Ore., asked Rettig for a plan to fix the imbalance. Rettig readily agreed.

Last month, Rettig replied with a report, but it said the IRS has no plan and won’t have one until Congress agrees to restore the funding it slashed from the agency over the past nine years — something lawmakers have shown little inclination to do.

On the one hand, the IRS said, auditing poor taxpayers is a lot easier: The agency uses relatively low-level employees to audit returns for low-income taxpayers who claim the earned income tax credit. The audits — of which there were about 380,000 last year, accounting for 39% of the total the IRS conducted — are done by mail and don’t take too much staff time, either. They are “the most efficient use of available IRS examination resources,” Rettig’s report says.

On the other hand, auditing the rich is hard. It takes senior auditors hours upon hours to complete an exam. What’s more, the letter says, “the rate of attrition is significantly higher among these more experienced examiners.” As a result, the budget cuts have hit this part of the IRS particularly hard.

For now, the IRS says, while it agrees auditing more wealthy taxpayers would be a good idea, without adequate funding there’s nothing it can do. “Congress must fund and the IRS must hire and train appropriate numbers of [auditors] to have appropriately balanced coverage across all income levels,” the report said.

Since 2011, Republicans in Congress have driven cuts to the IRS enforcement budget; it’s more than a quarter lower than its 2010 level, adjusting for inflation.

Recently, bipartisan support has emerged in both the House and Senate for increasing enforcement spending, but the proposals on the table are relatively modest and would not restore the budget to pre-cut levels. However, even a proposed small increase might not come to pass, because it’s unclear whether Congress will actually pass any appropriations bills this year.

In response to Rettig’s letter, Wyden agreed in a statement that the IRS needs more money, “but that does not eliminate the need for the agency to begin reversing the alarming trend of plummeting audit rates of the wealthy within its current budget.”

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A Financial Checklist for Your Newly Minted High School Graduate

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A Financial Checklist for Your Newly Minted High School Graduate

The summer after high school graduation inevitably includes monthslong encounters with various to-do lists.

Extra-long-sheet purchases and milk crates for future collegians. A résumé for job seekers. Thank-you notes for all.

But let me suggest one more itemized offering: a list of financial tasks. If you want to set your child up properly for college, work, military service and the years beyond, there are several things you ought to do, help them do or teach them before too long.

Got a younger teenager? No time like the present to get started with a lot of this. Is one of your children already in college? You probably haven’t done all of these things yet.

This list applies to teenagers who face no major mental or physical health challenges. If your child does, revise at will, and please send me your own list via the email address below so I can publish one next year for young people who function differently.

Let’s get started.

[Sign up for the Your Money newsletter and every week you’ll receive tips on retirement, paying for college, credit cards and the right way to invest.]

Begin with a conversation about who is paying for what: room, board, phone, transportation, insurance. Pencil it out with a simple spreadsheet or one of the many budgeting apps that did not exist even a decade ago.

Food costs often flummox teenagers moving out for the first time. Takeout is tempting if they haven’t cooked much. If they splurge for meat, fresh fruits or vegetables at the grocery store, spoilage may take its toll. A practice month or two at home — where you don’t let them cheat by relying on staples like spices and oils already in your pantry — might be useful.

First bank account? Teach your teenager to balance a checkbook. Turn off overdraft protection to enforce budgeting and avoid fees, or at least make certain he or she knows how high fees are. Set up low-balance alerts. Install the institution’s app.

Are adults providing some funds from time to time? Make sure the transfer mechanism from their accounts is seamless and free of fees. Then, test how long it takes for the money to land.

Many teenagers are more facile with money-transfer apps like Venmo than adults. But when you can push money to anyone in an instant, mistakes will happen. And it may not be easy to fix them quickly.

Begin by setting up multifactor authentication and a PIN. Believe the warnings Venmo issues about not using the app to pay people you don’t know. Use the app’s code system — or at least the user profile picture — to be certain you’re paying the correct Emily Smith.

Speaking of mobile payment apps, just how good is your teenager’s password? Is it something a rogue piece of thieving software could easily guess? Has your child repeated passwords across sites in a way that might leave them vulnerable? This is a good time to ask.

Identity theft doesn’t just happen electronically. Make sure your child’s Social Security card isn’t in a wallet; it’s better to carry the number in memory. Moreover, help your teenager learn when not to share it.

Debbie Schwartz, founder of the Road2College website, heard from her daughter that her sorority was asking after her Social Security number. “She questioned why, and they didn’t have a good answer,” she said. Her daughter never handed it over.

Doctors often ask for a Social Security number. Have your child ask if the doctor truly needs it, or leave the spot blank on an intake form and see if anyone cares.

Has your child ever made a doctor’s appointment? Fix that. Outsource form management as well. My teenager was twice as fast as me on the tablets that many doctors use for intake these days anyway, so good riddance to all that paperwork.

Your children can stay on your health insurance plan until the age of 26, thanks to the Affordable Care Act. If you plan on having them pitch in for deductibles, it’s probably time to sit down and explain how your family coverage works. At the very least, they need to know what a co-pay is.

According to the scores of parents who responded to my query on Grown and Flown, a website and Facebook group for parents of teenagers and young adults, filling a prescription for the first time is filled with interesting obstacles, especially on refills for regular but essential medicines. So introduce your child to the various insurance cards and account numbers he or she needs, and do a walk-through with your local druggist or whatever mail-order pharmacy your insurance company forces you to use.

Most employers that issue formal paychecks will require your teenager to fill out the Internal Revenue Service’s W-4 form. So review it to explain what it is and what kind of taxes, if any, your teenager might pay.

Do you get confused when you have to fill out your own every so often? There’s no shame in that, and the I.R.S. has a calculator that can help. And if it looks like too much money, or too little, is showing up in the first check after the withholding of taxes that you specified, you can revise the form.

If compound interest isn’t officially the eighth wonder of the world, then it ought to be. The sooner teenagers start saving, the more they could benefit from its magic as it unfolds over a half-century or more.

Show your teenager a chart of the vastly higher returns possible for those who begin earlier, like the one I tweet out from time to time. Then, set your child up in a Roth I.R.A., where money can grow tax-free for decades and isn’t subject to taxes once it’s withdrawn in retirement.

You can open a Roth I.R.A. only for someone who has already earned money working, but it doesn’t matter how young the person is. If there isn’t much money, that’s fine; getting started early is partly about making savings a habit.

Fidelity, Vanguard and other brokerage firms offer ways to open an account for next to nothing in fees.

Many young people have spotty credit reports for the first few years of adulthood. Perhaps they’re confused by our confounding student loan system and miss a few payments early on, or they miss other bills here and there before someone explains that every late payment matters.

Parents can help set a good baseline by getting what’s known as an “authorized user” card in a child’s name. Even if you just put it away in a drawer, away from temptation, your own regular payments will accrue to your child’s formerly blank credit report.

Card companies handle these accounts in different ways. You’ll want to ask whether an authorized user needs to be a certain age, whether there’s an annual fee for the extra card and whether the card company will penalize children if parents pay their own bills late.

Child identity theft is a problem, and the three big credit bureaus — Equifax, Experian and TransUnion — have grudgingly begun to allow people under 18 to freeze their credit files. When a file is frozen, creditors generally won’t open a new account because they can’t check the applicant’s credit. That should stop thieves who are trying to impersonate your child.

Setting up a freeze is a bit of an ordeal, and I’ve written a column-length guide to the process and a follow-up on how Equifax was making it needlessly difficult for some people. But it’s worth the effort.

A credit freeze isn’t supposed to prevent you from adding your child as an authorized user on your credit card. But just to be safe, it’s probably best to wait to set one until after you have an authorized user card in hand.

When applying for financial aid, which includes the ability to gain access to the federal student loan system, families must fill out a Free Application for Federal Student Aid form. It contains lots of financial information, including household income. Students and a parent are both supposed to sign it and attest to its accuracy. If your child was an active participant in filling out the form, great. If not, go over it now.

It’s as good a time as any to talk to your teenager about how much money you make. After all, if your child aspires to a life like the one you’ve provided (or wants to live larger or thinks less will do), he or she needs some context. This knowledge can influence your child’s choice of major, so better to have it now.

Worried about children blabbing? Remind them that most people don’t care about your family income and that if they talk about their parents’ higher-than-average earnings, people will probably think they’re a jerk.

Students borrowing from the federal government will get different loans at different times over their college years. Keeping a running tab and a list of loan numbers is a good idea so you can be organized when repayment begins.

If your undergraduate is already a few years in, you can look up all of his or her federal loans via the National Student Loan Data System. Got private loans? You’ll need to contact your lenders for information.

Once you have the data you need, make a list so you have everything in one place. The internet is filled with simple spreadsheet templates that make this easier.

Once children turn 18, they have all the grown-up privacy rights that come from the Health Insurance Portability and Accountability Act, and the power to make their own medical decisions. This can create challenges when a student gets sick or is incapacitated, and parents are sometimes shocked to find that paying tuition doesn’t necessarily give them overarching authority or instant access to information.

Parents who want to preserve some authority and access will want to consider filling out two forms, according to Molly E. Philipps, chief counsel of the civil division of the student legal services group at Ohio State University.

First, there’s the health care power of attorney, which some people call a medical power of attorney or a health care surrogacy form. This form gives someone else the ability to make medical decisions for someone who is incapacitated, and it may also grant the right to see the patient’s medical records. Not every undergraduate will like the idea of granting access to health records, so be prepared for a possibly complicated discussion.

The second form, a Hipaa release, might seem duplicative, given that it also provides access to medical records. But Ms. Philipps said the Hipaa document extended that access even after a person’s death, which makes it useful if the quality of care is a source of dispute.

General Hipaa releases exist on the internet, but it’s worth asking each medical practitioner or a university health services or counseling office whether it has its own proprietary forms that it wants families to use.

Even if you’re paying every penny of your child’s college tuition, you do not have the right to see his or her grades or disciplinary record.

The federal Family Educational Rights Privacy Act sets the rules for who gets to see what when. If you want access to your child’s grades, you’ll have to have that (perhaps challenging) conversation first and then have your child sign a release, probably through the college registrar’s office.

Ms. Philipps at Ohio State has seen it all, given that hers is one of the largest collections of undergraduates in the United States. And insurance problems come across her desk more than you might think.

When it comes to automobiles, she encourages parents to talk to their insurance companies about liability coverage if a student is going to be living in a different state for a while. Planning on removing your student from the family insurance policy while he or she is on campus? You may want to reconsider: People sometimes drive their friends’ cars.

Off-campus landlords sometimes require renters insurance, so you may be shopping for a policy whether you want to or not. Even if you have thorough homeowners insurance that extends to an on-campus child, a separate policy may be a better bet. Your own deductible may be high enough that a stolen iPad isn’t worth a claim — especially if it might still cause your premiums to surge.

Health insurance is a particularly thorny topic: Some colleges and universities push their own policies, and campus or local clinics often maintain their own idiosyncratic insurance rules.

My colleague Roni Caryn Rabin wrote an excellent primer on all of this two years ago, walking readers through the insurance questions they should ask: Does the campus health center take my family plan? What are the costs if it doesn’t? Is there an in-network doctor near campus? What about the type of specialist my child needs to see regularly?

Once you sort your situation out, you can explain to your child what, if anything, care might cost.

Take the 7-Day Money Challenge

Let us help you work through the essentials of your financial to-do list. Tackle a simple money task each day for a week to strengthen your financial well-being.

Helping a teenager who is about to enlist is a trickier matter. Your authority is diminished — you’re not writing tuition checks, and your child will no longer be living with you. And some young adults may have chosen this path in part because they seek independence at the earliest possible age.

Nevertheless, most teenagers don’t know what they don’t know about money. (Middle-aged people too, for that matter.) And a multiyear stint in the military is a real job with benefits that would be foolish to ignore. So try to at least get a few things under their noses if you can.

The Army, Navy, Air Force, Marines and Coast Guard all have their own websites that outline salary and benefits. The Marine Corps cleverly directs interested parties to a recruiter who can answer questions. Here are two you might suggest asking of a more experienced enlisted person: What benefit have you valued most, and which one do you wish you had known about or started using sooner?

Starting an automatic savings habit ought to be high on the priority list, and members of the military have access to the government’s Thrift Savings Plan to prepare for retirement. The Consumer Federation of America coordinates a campaign called Military Saves that can help both with establishing financial goals and making plans to meet them.

Young adults getting regular paychecks for the first time are prime targets for shady financial services companies. The Consumer Financial Protection Bureau’s Office of Servicemember Affairs sends out email blasts and maintains social media accounts that provide tips. It has also published a number of useful guides to borrowing money safely and dealing with debt collectors if things go awry.

Finally, there are the education benefits that come with military service. It’s not too soon to start thinking about how the G.I. Bill can help pay for higher education, including vocational training.

Email: lieber@nytimes.com.

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Do these five things to get to your first $10,000 even if you have no money

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Do these five things to get to your first $10,000 even if you have no money

Grant Sabatier, 33, says building a relationship with your money is the key to having more of it.

Source: Grant Sabatier

Want to see a five-figure balance in your bank or investment account?

Two things to know.

Starting is the hardest part. Next hardest: getting to that first $10,000.

Then it gets easier.

If anyone knows how to get to $10,000 with sure, definite steps, it’s Grant Sabatier of online personal finance community Millennial Money. Just about 10 years ago, a 20-something Sabatier was broke, and the future looked bleak.

Today, Sabatier, at 34, is worth more than $1 million and has just published his first book, “Financial Freedom.”

Money is only stressful if you don’t build a relationship with it, Sabatier says. To do that, he recommends looking at your net worth every day. It will be stressful for a while, he admits.

“Then, at some point, maybe the 30th or 40th day, you log into your account, you are used to it,” he said. “It becomes less stressful and you don’t fear it as much.”

You can absolutely get to $10,000 without a side hustle. “It would depend on salary,” Sabatier said. It all comes down to spending habits and aggressively funneling money into investments.

Cutting costs doesn’t have to go on forever. “Just make a couple of these changes for the next six months to get to $10,000,” Sabatier said. “Then see how you feel.

“When you get to the $10,000 level stop and look around,” he added. “Take the time to reflect and see if one tradeoff was worth it or not.”

1. The need for speed

One of the hardest things about getting started is that you don’t yet have the essential habits. When you’re building the habits, growth is slower. “The smaller your investment balance, the more slowly your money grows,” Sabatier said.

The first 90 days are key, because that’s where you need to work hard to build momentum.

The longer you take to get there, the harder it will seem. Saving up $10,000 in five years will seem like a burden. “If you do it in a year, you’ll say, ‘Wow! In five years, I could have $50,000,'” Sabatier said.

2. Save more by a tiny amount

3. Invest your side hustle cash

Sabatier made $60 taking care of his neighbor’s cat, among other side hustles. Instead of spending it, he deposited it right away into his brokerage account.

That is another way to manually increase your savings. Take any extra money, whether it’s a few dollars you find around the house or a forgotten $10 someone returns to you. Instead of treating it as surprise cash to buy lunch, invest that money.

“Every dollar you make on the side, invest as quickly as possible,” Sabatier said. “Because you want to get the extra money you’re making to start working as quickly as possible.”

4. The roundup strategy

Contrary to popular recommendations, Sabatier checked his net worth daily. If the number was $7,987, he’d come up with $13 to invest, just so he could round it up to an even $8,000.

“I’m a little OCD,” he said.

His no-fee method was to deposit bits of extra cash into a money-market account in Vanguard. When he had accumulated enough, say $200, he’d invest it in low-cost index funds.

The point is to use mindset to get extra money into your investment account.

5. The double-up strategy

If you are not investing any money at all, it’s hard to imagine you can actually reach $10,000.

It’s definitely not a good idea to fool around with retirement calculators. The person who is saving a minuscule amount —say $10 a week — can be in for a rude shock: the error message.

It’s daunting, to say the least, to be told it will take you 487 years to reach retirement or to get an error response.

Instead, Sabatier recommends starting with smaller numbers and more manageable goals. “Once I’d save $500 to invest, my next goal was $1,000,” he said. “It’s a mindset trick to get to your first 10,000.”

So go ahead and start small. If you’ve saved $10, make your next goals $20 and $40.

Check out Don’t Fall For These 5 Myths About Money via Grow with Acorns+CNBC.

Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.

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