Artificial intelligence, or AI, seems to be everywhere all the time right now. As an investor, you might be asking yourself – why is this happening now, and should I jump on this trend? AI has been around for decades and has had multiple start-stop moments for investors, but this time admittedly feels different. There are a few reasons for AI being ubiquitous at the moment, including faster computational power, less expensive technology, advancements in algorithms, increased volumes of data, an enormous amount of capital investment, and, well, it is now available to people like you and me. With so many forecasts about how AI will change many industries, it’s worth a discussion about how you as an investor can benefit from it.
The good news is that you may already have plenty of exposure to AI. As you read this, consider the fact that AI is currently present in many ways across many industries and will be even more places soon. However, the AI-craze feels very reminiscent of the Covid Work From Home Boom back in 2020, when names like Zoom, Peloton, Shopify, Teladoc, etc. were all the rage. The ride up was spectacular for these names, and – as the chart below shows - the fall has been equally spectacular for some who entered at the wrong time or were not disciplined in their rebalancing process to trim profits along the way.
The lesson from the Covid era “theme” investing is that some parts of a theme are just a fad, and some parts are a whole new way of life. And even with the compelling growth opportunities that themes can offer, the excitement about AI shouldn’t outweigh thoughtful investment management strategy. A prudent investor's good friends are diversification and disciplined rebalancing. While we believe in the long-term runway for AI and will maintain a healthy exposure in the portfolios we manage for our clients, we know that disciplined buying and methodical trimming of gains as sectors outperform is a key component to long-term success.
Depending on the type of investor you are, we have some ideas for you. Please note that the ideas and examples below are in no way a recommendation for our clients or readers. Our clients have an appropriate amount of AI exposure in their portfolios, and we do not make recommendations on investments without having a complete understanding of an investor’s goals, timeline, and risk tolerance and capacity.
I want to benefit from AI in general, but I don’t want to increase my risk or the amount of time I spend on my portfolio.
You may already have what you need if you own large cap US stocks through an exchange-traded fund (ETF) or a mutual fund. As an example, our recent review of two sizable US large cap ETFs – one focused specifically on growth companies and one focused on broad large cap exposure - revealed significant direct exposure to companies that are at the forefront of the AI explosion. Top holdings in both ETFs included Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Nvidia (NVDA), and Google (GOOG). Additionally, AI will be pervasive in many industries, and investors in diversified portfolios can benefit from exposure to a broad base of companies who will use AI to advance their success in many different ways.
I want to have specific exposure to AI, and I understand that this increases my risk level and will require some research on my part.
As with most industries, ETFs have been created to hold stocks exclusively related to the AI industry. Multiple investment firms offer AI-focused ETFs, so a proper amount of due diligence is required to find the one that would be suitable for your investing goals. If you designate a portion of your portfolio to the AI industry alone, you should also understand that this inherently increases your risk level. As an investor, you should expect that anything that can potentially perform better than the overall stock market can also lose more than the overall stock market. Think about the overall risk that you can handle in your portfolio and consider dialing the amount you invest down to a point that it will not upset your risk budget for your broader financial goals.
I want to find the next big AI stock, and I am willing to increase my risk level considerably and the amount of time I spend monitoring my portfolio.
Start-up stocks have some of the widest risk/reward possible outcomes. The value of a stock can go to zero if a company folds, which is entirely possible with start-up companies in an industry that requires such intense capital as AI does. On the other end of the spectrum, Nvidia (NVDA) is up 165% YTD and trading close to $390 per share with a P/E ratio just over 200 (as of June 9, 2023). By contrast, the S&P 500 index is up nearly 13%, and has had a P/E ratio in the low 20s recently. This performance highlights that an investor who can find a “next big thing” company like Nvidia before the rest of the world knows about it can potentially walk away with enormous profits in a short period of time. However, buying start-up stocks also requires that an investor understand and accept the risk of possibly losing 100% of the invested dollars. Either way, the path of trying to find the next Nvidia requires a concentrated time commitment to research and monitor the stocks.
If AI is here to stay, as many believe, investors have the potential to benefit from the efficiencies it may bring to a variety of industries. But even the enormous potential that AI - or any investment theme - has should not disrupt the construction of a portfolio that has been thoughtfully designed to meet your needs.
If you know someone who would benefit from a complimentary review of their portfolio, they can contact us at email@example.com.
Debra Brennan Tagg is a CERTIFIED FINANCIAL PLANNER™ Professional and the creator of the DBT360 Financial Plan, a proprietary program that helps her clients prioritize their goals, leverage their resources, and address their risks. She is the president of BFS Advisory Group and teaches the public and the financial services industry about the importance of values-based financial planning and investor education.