Lets jump into what algorithm based investment products are and what possible advantages could be provided by such investments over manual based analysis:
An algorithm is a well-defined procedure that allows a computer to solve a problem. So when algorithms are applied to investments, it provides them with a much needed definitive structure and discipline.
a. Efficiency – In algorithm based investments collection, analysis and filtration of data when automated can bring tremendous benefits to a process of investment. Handing over the job of collecting data that is repetitive in nature can bring down manual effort by a considerable amount. Manually if a firm can analyze 100 companies in a month, the same thing can be done a computer within minutes. If a company based on manual analysis need to speed up its process, it needs to hire more employees. This may not be a viable option for a lot of firms that cannot afford such high costs thereby limiting efficiency.
b. Elimination of bias – As humans we all have inherent biases that can play outwhile taking a decision due to our emotions. These emotions need to be kept at bay when investments are concerned as they can maneuver decisions in directions that can lead to losses. The titan investor Warren Buffet has an apt quote to summarize this point ”If you cannot control your emotions you cannot control your money”. Also, any bias based on size of investment is eliminated by deploying such an algorithm centered investments. Small scale investors will not have to worry about being ignored over HNIs as a computer does vary in effort based on economic background of an individual.
c. Reduction in scope of human error – In areas of profession like the stock market where people have to be highly alert, small mistake can have massive negative impacts. By transferring the job of analysis and buying and selling to logic based algorithms, human errors are radically minimized as the whims of human are completely ignored by algorithms. Human are bothered by various reasons that could translate into negligence which could then result in portfolios being negatively affected.
d. Accountability – As every step of a process is well defined, any errors that arise can be traced back to the cause of such disruption and fixed quickly. This aspect of accountability also provides a client with a sense of security. As portfolios are managed through these algorithms, clients can be rest assured that each portfolio is being looked after with the same care and that the algorithm based investment firms take accountability for all the portfolios equally.
e. Transparency – One of the primary concern investors have is with regards to transparency. It is a company’s policies that majorly determine this aspect but having algorithm based investments just adds on to this much needed transparency. With every step having defined functions, when clients are made aware of these processes, they can for themselves know why a buy or sell is happening in their portfolio and how everything is going about.