A concerning example of how AI makes simple financial mistakes, and the right and wrong way to use AI to make financial decisions.
Topics covered include:
- How AI ignores the time value of money
- A detailed example of ChatGPT misleading by making a simple math mistake
- Some examples of opportunity costs and sunk costs when making financial decisions
- Understanding how AI works can help us use it more effectively
Show Notes
What Kind of a “PhD-level Expert” Is ChatGPT 5.0? I Tested It. by Gary Smith—Mind Matters
Top US Army General Says He’s Letting ChatGPT Make Military Decisions by Joe Wilkins—Futurism
Why Language Models Hallucinate by Adam Tauman Kalai, Ofir Nachum, et al—Arxiv
Auto Loan Calculator—nerdwallet
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 542. It’s titled “Don’t Take Financial Advice from AI.”
Comparing Auto Loans
Here’s a question in personal finance. An individual needs to borrow $24,000 to buy a car. Should they get a one-year loan at 10% or a 20-year loan at 1%? This was a question that AI skeptic Gary Smith, who runs the website Mind Matters, asked ChatGPT 5 in order to illustrate that the model fell short of OpenAI CEO Sam Altman’s claim that ChatGPT 5 “Really feels like talking to an expert in any topic, like a PhD expert.”
I asked ChatGPT 5 the same question. It went through the math, showed its work, and concluded that the one-year loan was the better option, because the total interest paid was less than the 20-year loan. In fact, Chat said that the one-year loan was far better financially. Gary Smith concluded that ChatGPT 5 erred because it didn’t take into account the time value of money. He wrote, “A dollar paid this year is more financially burdensome than a dollar paid 5, 10, or 30 years from now, with the size of the difference depending on the rate of return that the borrower can earn by deferring loan payments.”
Another way to describe the time value of money is a dollar received or saved today is worth more than a dollar received or saved 10 years from now. That’s because the dollar could be invested to earn a rate of return.
Gary Smith continued, “Ordinary people living in the real world know that a 20-year loan at 1% is nigh irresistible, and certainly more attractive than borrowing for one year at 10%.” I don’t know, what answer did you come up with? Was the one year at 10% better, or 20 years at 1% for a car loan?
I asked ChatGPT 5, “How is the one-year loan at 10% better financially?” It’s an excellent question, and it’s a subtle one. It comes down to how long the money is borrowed, and the total interest paid, not just the rate. Then it went through the math again and concluded that the short loan is better financially, because you’re debt-free in one year instead of 20, you pay less total interest, $1,351 with the one-year loan, versus $2,467 with the 20-year loan.
It said you avoid long-term risk, such as needing to sell the car long before the loan is paid off or facing financial changes over 20 years. The risk of being upside down on the loan which is legitimate. That’s why they don’t lend on cars for 20 years, because the car will depreciate much faster than the loan value, even if the interest rate is 1%.
But still, in all this interaction, AI hadn’t really considered the time value of money. So I wrote, “A researcher said you erred on this answer”, and I explained what Smith said regarding the time value of money. I just pasted it, and chat replied, “That researcher is absolutely right, and that’s an important nuance.
Let’s restate the question properly, with the time value of money in mind.” And then it did an exercise calculating the present value, the value in today’s dollars of that one-year loan payment with interest at 10%, versus the 20 years of payments with interest, and at a 5% discount rate, the present value of the one-year loan at 10% is $24,679. The present value cost is how it put it. For the 20-year loan at 1%, the present value cost was $16,451.
Since we’re making payments, the lower the present value, the better. If we were receiving that cash flow in terms of an income stream, then the higher the present value, the better. So based on its calculation, using a 5% discount rate, the 20-year loan at 1% had a lower present value, so it was the better option. And then it did a true trade-off. The one-year loan at 10% is cheaper in nominal terms, in terms of less total interest and not having a very long-term debt. But in present value terms, the 20-year loan is better. Great.
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