Artificial intelligence technology has massively disrupted the financial sector. Joe McKendrick posted an article in Forbes on the role that AI will play in the coming democratization of financial services.
There are many other reasons AI and big data technology is changing finance. One of the biggest is that more financial institutions are using predictive analytics tools to assist with asset management. Predictive Asset Analytics, Riskalyze and Altruist are some of the tools that use predictive analytics to improve asset management for both individual and institutional investors.
This article will provide an overview of the concepts of asset allocation and fixed asset management, before delving into some of the unique benefits afforded by predictive analytics technology.
What is asset allocation and how can predictive analytics improve its effectiveness?
You’ve probably heard of the old adage, don’t put all your eggs in one basket. Asset allocation is taking this advice and applying it to your investments. Not only can it help you build a profitable portfolio, but it can also provide a degree of protection for your future.
Asset allocation is a strategy that divides your money between different asset classes in your portfolio. Counteracting volatile investments with less volatile ones increases your stability and chances of generating greater returns overall.
The good news is that predictive analytics technology is making it easier for people to boost their ROI and tweak their portfolios to align with their investment goals. Brad Fisher a Partner and Data & Analytics Lead for KPMG has talked about some of the advantages that predictive analytics plays.
“In today’s challenging business environment, it is not enough to do an average job managing fixed assets. Enabling technology and people skilled in interpreting data have resulted in a convergence where predictive analytics can and should be an integral part of most, if not all, business operations,” Fisher writes.
How do I use predictive analytics to improve my asset allocation strategy?
Predictive analytics technology can help optimize your profile to better meet your investment goals. However, if you don’t establish clear, objective goals in the first place, then you won’t benefit from utilizing predictive analytics.
Before you can create a strategy, you must determine your risk tolerance. Finding the right balance between risk and reward is all about your establishing personal investment goals. So you have to ask yourself, how much volatility are you comfortable with? Ultimately, the decision of how to allocate your funds is personal, and there is no right or wrong answer.
Once you have outlined your risk tolerance, you will have an easier time using predictive analytics tools to improve your asset allocation strategy. This means you need to consider the following two factors. Here are the two factors that you need to take into consideration when using predictive analytics to improve your portfolio management strategy.
● Time Horizon
The time horizon boils down to what your short-term and long-term goals are. Will you need the money you’re investing within the next year or ten years from now? You may find that your age can play a big part in your answer to that question. For example, a young investor might not need their saved-up money for some time, while an older investor who is retiring soon may want to access it in the near future.
Adversely, age might not play a role at all. Let’s say you want to take an expensive vacation this year and need the money within the next six months. In that case, you have a short time horizon.
Predictive analytics tools like Predictive Asset Analytics by AVEVA will take the timeframe of your investing decisions into consideration. The AI algorithms will evaluate the likely performance of assets over various time intervals and discount any outcomes outside the desired timeframe.
● Risk Tolerance
Your risk tolerance is how much you’re willing to risk losing to potentially get a greater return. Do you prefer to play it safe or put it all on the line? There are a few things to consider when weighing your risk tolerance. Someone that is just starting out and has a small amount of money but more time to play with may be more willing to make volatile investments. They want to build their portfolio and have years to rebound from any losses. Someone in the later stages of life may not want to take such a big roll of the dice.
Predictive Asset Analytics and other predictive analytics applications for asset management will evaluate the probable volatility of various market conditions to assess the risk of making short-term and long-term investments during those periods.
Last year, Xiafei Li and his two colleagues in China published a study in the Annals of Operations Research on the ability to forecast stock market volatility with predictive analytics models. Their research showed that economic policy uncertainty indicators and CBOE volatility index (VIX) indicators are better for predicting market volatility than financial indices. Therefore, these metrics are likely to be used by most predictive analytics tools used to ascertain risk.
As you can see, these two factors play off of each other and predictive analytics technology can help manage them more easily. Your time horizon will likely influence your risk tolerance and vice versa. It’s all about determining what will work best for you. Predictive analytics tools like Riskalyze and Altruist will help with portfolio management, but you still have to establish your goals first.
What are the different types of assets in your portfolio that predictive analytics can help manage?
So, you’ve set your personal investment goals, and you know where you stand regarding what’s important to you. You have also invested in new cutting edge software that uses predictive analytics to help manage your portfolio better.
What’s the next step? You want to look at the types of assets and how they will comprise a diverse portfolio. While there are a growing number of classes, the following are the main categories.
When you purchase a stock, it represents your share of the company you invested in. It can be the riskiest investment you make, but it can also have the biggest returns. Its volatility depends on many factors, including the company’s performance, the economy, and the political environment. Due to its unpredictable nature, it’s generally recommended you hold stocks for five years or longer.
Bonds involve lending money to a company or government entity for a set period of time. The company or entity will then pay you back your investment plus interest. Overall, they are less volatile than stocks and a great diversification asset that can help balance your portfolio. They offer stability, but the returns probably won’t be as great as stocks long term.
● Cash Equivalents
Cash equivalents are meant to be held short term, typically a year or less, and include certificates of deposit (CDs), treasury bills, and bankers’ acceptances. They are the most liquid asset, meaning you can tap into them anytime with little or no penalties. They are one of the lowest-risk investments and tend to have minimal returns.
● Real Estate/Tangible Assets
Real estate and other assets such as livestock, gold, and silver can be used in investment strategy. They have a low correlation to market movement and typically perform well during rising inflation, which helps offset risk in a portfolio.
Predictive analytics software can help with managing all of these assets.
Should I use financial software that uses predictive analytics to help with asset allocation?
The easiest way to manage your asset allocation is with financial software. Sites like Stock Market Eye take all of the guesswork out of investment portfolio reporting. Many of these tools also use predictive analytics to forecast future asset prices with their valuation models.
They break down every aspect into allocation reports, transactions, gains, losses, and returns. You can even view what your portfolio looked like on a specific day with their Back-In-Time Report feature.
Are there any risks associated with asset allocation?
Investing is a venture that comes with a degree of uncertainty, but asset allocation can help you better understand how to take calculated risks. What level of risk, of course, is entirely up to you and what you want out of your experience.
Take your portfolio to the next level with asset allocation
The role of asset allocation in portfolio management is all about risk versus reward. Creating a diverse portfolio with uncorrelated assets can balance your volatility and potentially increase your returns. Are you ready to take your investments to the next level?
Predictive analytics is the future of financial asset management
There are tremendous benefits of using predictive analytics technology for asset management. We previously pointed out that predictive analytics software can help Forex traders, but other investors can benefit from it as well. You will want to familiarize yourself with the benefits of AI and use it to your advantage.