Why the wisdom of the market crowd beats artificial intelligence

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The author is founder and president of Dimensional Fund Advisors. The University of Chicago Booth School of Business is named after him.

Can Artificial Intelligence Help Choose Stocks? More specifically, can investors use AI to determine the fair price of a stock or bond? I bet many people right now would say yes, given recent advances that enable ever-increasing amounts of information to be processed.

I think mine TO THE it’s better than all the others out there. My AI is the market.

For example, choose an action. Check the price. Why is that price exact? Because an equal number of buyers and sellers think they are getting a good deal when they sell or buy it at exactly that moment. They express these judgments using any information available to them, both public and private. The market is the world’s largest information processing machine, creating a price for every publicly traded stock and bond.

These prices are set in an environment where nobody knows what will happen. So in that sense, it’s a giant model that’s humanity’s best guess and ever-changing about how each company’s stock or bond is going to behave.

Despite all the promises of AI, I’d rather accept market prices than algorithm prices. Large language models, the kinds of AI that power tools like Chat GPTthey are intended to understand and generate text that appears to be created by humans, not to predict future outcomes.

They can generate potential scenarios based on learned models, but struggle to account for unknown factors or real-world changes that lie outside their training data. In this way, they are truly “artificial”, while markets are composed of real human intelligence and the millions of judgments market participants make.

Sure, AI and algorithmic trading can help trade execution. But there’s no reason to think that AI should fundamentally influence how people think about stock prices anytime soon.

The market is extraordinarily complex. So much so that no one knows exactly how much a particular piece of information affects a price, because there are so many other simultaneous inputs. But the market guarantees that a price is the most accurate current representation of the value of a stock or bond. It is free and available to everyone. How awesome is that?

This is not just my opinion. There is a lot of evidence to support this. In fact, it’s a 50-year-old theory that gets more and more proven with each passing year. Google “efficient market hypothesis”. Better yet, ask ChatGPT to explain it to you.

Still don’t believe me? So let me ask another question: Do you think you can hire a manager to implement the strategy of using AI to pick stocks that consistently beat the market? After taxes, probably not. If they had a great AI that actually predicted stock prices better than the market, why would they share the information with you?

What’s takeaway? You can have a good experience without worrying about all those things. Based on nearly a century of data, the stock market has been gaining about 10% a year, or 7% more than inflation. This was true before and after computers, before and after the Internet, and even before and after World War II. It makes sense to me that this will continue to be the case after AI. Because our AI is “aggregate intelligence,” which includes AI and improves on it.

To be clear, I celebrate the innovation this moment can represent. As I have seen time and time again over the past 50 years of my career, many players will seek to take advantage of the latest technological advances to improve their company and even create new ones. By buying the market, you can have a share of all publicly traded companies.

And if I still haven’t convinced you, I asked ChatGPT: “Is it safer to trust the market pricing mechanism than to rely on an AI model to find mispricing in stocks and bonds?”

Here’s what I got the day I asked: “It’s generally safer to trust the market pricing mechanism than it is to rely on an AI model to find mispricing in stocks and bonds. The market pricing mechanism is based on the collective actions of all market participants and incorporates all available information into asset prices. As a result, it is difficult for any single investor or AI model to consistently outperform the market by identifying mispricing.”

So if you don’t trust me, trust the AI ​​that is telling you not to trust the market’s AI.