ChatGPT and Financial Planning

AI's Impact

For a few years, I have been trying to learn more about how wealth advisors and Certified Financial Planners (CFPs) go about their business of solving the financial questions of their clients and building long-range financial plans. Conjecture about which investments will outperform the market has too much focus and visiting actual performance too little discussion. Well-trained planners know something their clients do not: they can’t beat the market routinely. How would the average client ever know to have the discussion with their planner about back-testing the planner’s ideas versus risk-adjusted, “set it and forget it” portfolios? Normally, clients do not speak the language.¹

Wealth management clients are clients because investment terminology can be overwhelming and tax planning complicated. Anybody who has the talent and fortune to create wealth should continue to do that. Leverage the advantage and leave personal management details to others. Still, I have a strong hunch that client households don’t know how to evaluate the set of services offered by their planner. I see this indirectly. Parents of college students are advocates for financial literacy because parents think knowing finances is inherently valuable. It isn’t just the 4-year university crowd. Public policy has shifted with tax dollars floating toward financial education at earlier grade levels.² I think there will be a reversion. Core education and the ability to think and “do” math will still matter. But, an educational focus and tax dollars devoted to financial literacy will be fluid because of AI.

Prediction: AI tools will decrease the demand for descriptive financial information provided by professional planners and increase the demand on professional planners to use mathematical tools to answer client questions.

How Do Planners Solve Complex Questions?

Households need the financial services industry to solve their problems and offer credible guidance via a thoughtful, intellectually rigorous decision framework for any substantial financial question. Trust me that corporations don’t hire softly trained chief financial officers to help with business decision-making. For families, rules of thumb and arm waving should never apply if there are decision tools to use.

To gain some insight, I asked an open forum community of fee-only financial planners (NAPFA) a typical type of household financial question that has a relatively high dollar impact: an education.

Suppose a client is a married household, both spouses working, with 1 child age 2.   The client wants to know if a 529 plan is better than a Roth IRA.   What tools do you use to assist in determining the better choice?

I received a few responses from the pros. Here is a partial quote:

“If the client is constrained and can only use a 529 or a Roth IRA, I'd go with the Roth.  The 529 earnings will be tax-free if used for education expenses, but taxable otherwise.  The assets will count as part of the family responsibility, reducing other financial aid.  Investment choices also tend to be more limited.”

Makes sense and is similar to other comments posted which listed the descriptive details of the plans and how they could be used for educational expense needs. Responses did touch on making education cost projections and turning to portfolio software to model future investment performance. This type of how-to is worthy of work and typical among planners. But, what about tools that can inform the decision to make the better choice? How can all this institutional know-how be assimilated into a clear goal?

For starters, I would state the decision question as follows:

Given all the household’s resources and constraints, does a 529 plan or a Roth IRA produce a higher living standard for the household?

Helping a household achieve its highest living standard is the point of financial planning. The living standard objective emanates from foundational economic theory and can be generalized to any financial decision as a practical, calculable, real-world objective. Where should we live? What is the best way to pay off a student loan? Should we buy life insurance? Is my retirement funding better met by a regular IRA, a 401(k), or a Roth? These types of questions have different institutional details, tax issues, and client nuances and preferences, but applied economics offers the same approach to crunching the data. My archive has many examples.

Some practitioners have moved in this direction with their practices and more will do so. It is the future. I am betting there will be software competitors for individuals and planners to use to implement these principles, but at the moment MaxiFi is the only game in town as far as a I know.

What About ChatGPT?

Is our artificial intelligence world informed on the matter? My thinking is that if standardized training of planners and advice exists in digital form, then it might be rolled up today via ChatGPT. Here it goes.

Question to ChatGPT: Is a Roth or 529 Plan better for educational expenses?

The ChatGPT response in about 15 seconds:

“Whether a Roth IRA or a 529 plan is better for educational expenses depends on various factors, including your specific financial situation and goals. Let's examine both options:

1. Roth IRA: A Roth IRA is primarily designed as a retirement savings account, but it can also be used to fund educational expenses. Here are some key points to consider:

• Tax advantages: Contributions to a Roth IRA are made with after-tax income, meaning you don't get an immediate tax deduction. However, the earnings on your contributions grow tax-free, and qualified withdrawals, including for educational expenses, are tax-free as well.

• Flexibility: With a Roth IRA, you have greater flexibility in how you use the funds. If you end up not needing the money for education, it can continue growing tax-free for your retirement. Additionally, you can withdraw your original contributions (not the earnings) penalty-free at any time for any purpose.

• Contribution limits: Roth IRAs have annual contribution limits, which may restrict the amount you can save specifically for education. As of 2021, the annual contribution limit is $6,000 (or $7,000 for those aged 50 or older).

• Financial aid impact: Roth IRA balances are not typically considered as assets when calculating financial aid eligibility, which could be an advantage if you're concerned about how your savings might affect your eligibility for need-based financial aid.

2. 529 Plan: A 529 plan is a specific type of tax-advantaged savings account designed for educational expenses. Here are some key considerations:

• Tax advantages: Contributions to a 529 plan are made with after-tax income, but the earnings grow tax-free. Qualified withdrawals used for educational expenses, such as tuition, fees, books, and certain room and board costs, are also tax-free at the federal level (and often at the state level, depending on the plan).

• Higher contribution limits: 529 plans generally have much higher contribution limits compared to Roth IRAs, allowing you to save more specifically for education. Contribution limits vary by state but can be in the hundreds of thousands of dollars or more.

• Limited investment options: 529 plans typically offer a selection of investment options, which may include age-based portfolios that automatically adjust their asset allocation as the beneficiary gets closer to college age. However, you are restricted to the investment options provided by the plan.

• Potential impact on financial aid: 529 plan assets are considered parental assets on the Free Application for Federal Student Aid (FAFSA), which can impact financial aid eligibility. However, the impact may be relatively modest, as parental assets are typically assessed at a lower rate than student assets.

In summary, choosing between a Roth IRA and a 529 plan depends on your priorities. If you want flexibility and potentially maximize retirement savings while also having the option to use funds for education, a Roth IRA may be a good choice. If your primary goal is saving specifically for educational expenses and taking advantage of higher contribution limits and potential state tax benefits, a 529 plan could be more suitable. It's advisable to consult with a financial advisor or tax professional who can provide personalized guidance based on your individual circumstances.”

Today’s ChatGPT and the Future

Wow. Three takeaways. First, AI has captured and presented a summary of the basic financial information related to 529 plans and Roth IRAs and presented it in the context of education funding. Will the future student need professors for the basic information? Second, my second hunch is that economics-based financial planning training today is de minimis among actual financial planners and aspiring CFPs. It isn’t pervasive. Therein lies the third takeaway. There is an immense business opportunity for planners. Math has been deployed and commercial software developed to help planners and their clients move beyond descriptive solutions. Planners can bring their deep institutional knowledge to the table without the need to be quants to use the software. Such an approach will be a street-worthy comparative advantage not soon be replaced by AI.

1. Burton Malkiel’s work gives subscribers of any educational background a thoughtful view of the topic.

2. Here is a recent blog post with its listing.