How to invest in AI – CNN Underscored

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In a world saturated with technology, the next big thing appears to be unfolding right before our eyes. While artificial intelligence (AI) can provide meaningful near- and long-term opportunities for investors, it’s important to translate a broad knowledge of the technology into the best game plan for how to invest in AI.

What is AI?

As a pioneer in the space, IBM, notes that AI is “technology that enables computers and machines to simulate human intelligence and problem-solving capabilities.” A wide-ranging definition with a nearly endless number of ever-evolving applications, AI algorithms are “modeled after the decision-making processes of the human brain, that can ‘learn’ from available data and make increasingly more accurate classifications or predictions over time.”

On the ground, you likely encounter AI when you don’t even know it — in everything from customer service interactions to your time spent on social media. Sometimes, you know it all too well, as an AI-driven bot directs an awkward conversation with, for example, an online retailer or voices over an obviously computer-generated post or advertisement.

AI works with technology, including GPS, chatbots and generative AI tools, such as ChatGPT, to craft, drive and sometimes enhance experiences, efficiency and productivity. At the same time, AI gets blamed for lots of things, such as cheating in high school, even when the evidence shows it might not be guilty.

Occasionally, AI gets used for no good, makes headlines and fuels a debate on its value, or lack thereof, to society. And, of course, there’s growing concern that AI is replacing and will continue to replace humans throughout large swaths of the workforce.

Like most tech, it’s neither good nor bad. AI can be both, or in between, depending on your perspective and the intent of the individuals and groups who utilize and deploy it.

Important factors to consider before investing in AI

We cited IBM for a reason. You might have heard of IBM Watson, the question-and-answer technology that beat two Jeopardy champions in 2011. The company laid the groundwork for Watson in the 1950s and has been researching AI for more than 70 years. In fact, it was just past the midpoint of the 20th century when AI took major leaps, driving early and modern-day computing.

When deciding how to invest in AI companies, this history is important for two somewhat different reasons:

  1. Just because AI hit the mainstream scene recently when ChatGPT became a household name, it has been around for decades.
  2. Even so, we’re still only in the early innings of AI adoption.

Research by fund company Wisdom Tree shows that life-changing technologies, from the automobile to color television to the smartphone, were not “instantly adopted” by the masses. No technology is. It tends to take years, if not decades, to penetrate 80% or more of households. To this end, as big as AI seems today, we have likely only scratched the surface.

Exploring AI stocks for investment

Wisdom Tree notes that the number of AI chips produced by companies, such as semiconductor industry leader NVIDIA, is expected to grow exponentially, with estimates for the size of the AI chip market ranging from $120 billion to around $400 billion by 2027, from its current level of roughly $67 billion.

Inside this history and growth, there’s another factor to consider before investing in AI. Semiconductor firms, such as NVIDIA, Advanced Micro Devices and Intel, create and sell the hardware that drives AI. And tech companies such as Microsoft, Meta Platforms (the parent company of Facebook, Instagram and WhatsApp) and Alphabet (parent of Google) create and deploy AI-based systems and solutions directly to consumers and businesses who use that technology with their customer bases.

These names represent only a few of the large and long-standing companies at the forefront of AI. Generally, it’s important to invest in the companies delivering the hardware, such as AI chips, and crafting platforms that run on AI. They’re the ones that stand to directly benefit from the boom now and going forward.

Simply using AI doesn’t make a company an AI company. For instance, a grocery store or other retailer who says they use AI are typically not direct players. Instead, they’re paying other firms for the technology.

Finding AI exchange-traded funds (ETFs)

To this end, if you search for AI exchange-traded funds (ETFs), you’ll find many options. Some include “AI” or “artificial intelligence” in their names. Some do not. As with any ETF, look at the fund literature to assess its strategy, methodology, performance and expenses as well as the stocks the ETF owns.

For example, if you weren’t aware of the relationship between semiconductors and artificial intelligence, you might miss semiconductor ETFs as a way to invest in AI. However, it’s these ETFs that have benefitted from the emergence of AI. For example, from the start of 2023 to early March 2024, the VanEck Semiconductor ETF (SMH), was up roughly 113%, thanks to its small number of holdings concentrated in leading AI semiconductor companies, including NVIDIA.

This said, you might not have to look much further than broad stock market indexes, such as the S&P 500 and Nasdaq 100. Investing in one of the many ETFs that mirror the performance of these indexes gives you significant exposure to leading AI stocks, including Microsoft, NVIDIA, Meta and Alphabet.

“By owning a total market index, an investor will already participate in some of the benefits of AI as those companies grow,” said Brian Tegtmeyer, a certified financial planner (CFP) and founder of Truly Prosper Financial Planning in Ohio. “For a more targeted approach to AI, I recommend ETFs over individual stocks to reduce the risk of single-company investments. If someone is set on investing in individual AI companies, they should only invest an amount they can afford to lose and not gamble their retirement.”

More than a few AI-specific ETFs, such as the Global X Artificial Intelligence & Technology ETF (AIQ), the Franklin Intelligent Machines ETF (IQM) and the WisdomTree Artificial Intelligence and Innovation Fund (WTAI), keep many of these same leading S&P 500 and Nasdaq stocks at or near the top of their list of holdings, but sometimes in smaller concentrations. A broader stock market tracking ETF can provide meaningful exposure to AI as well as broader diversification across the entire economy or tech space.

Also, be wary of leveraged and inverse ETFs that generate 2X or 3X the return of an index, such as an index that tracks AI stocks. These ETFs are complicated and risky and generally not suitable for long-term investors.

Conduct thorough due diligence on AI-specific anything in investing. Many of the leading tech companies of the last few decades also sit at the forefront of the AI revolution. Depending on how much AI you want in your portfolio, your search could begin and end with them.

Pros and cons of AI investments

As part of your due diligence, consider the pros and cons of investing in AI assets:

Pros

  • We’re in the early stages of AI adoption, so there might be significant near- and long-term upside.
  • Many of the world’s AI leaders are well-established tech companies with stocks that have performed well over the long term.
  • AI can provide investors with international exposure, as AI continues to expand internationally.

Cons

  • Legal, regulatory and ethical issues could impede the growth and adoption of AI.
  • Tech stocks, particularly the ones with an AI focus, have performed well in recent years, but there’s no guarantee this will continue. Plus, these stocks sometimes experience periods of relatively high volatility.
  • If you stray from tech leaders, you might be taking a chance on young companies that lack track records of execution and success.

Frequently asked questions (FAQs)

Focus on companies directly involved in developing and deploying the hardware that drives AI as well as firms that create and utilize AI-powered software platforms for consumers and businesses. Be skeptical of non-tech companies who claim they use AI. While they might be appropriate investments in their respective market sectors, they’re not necessarily AI investments.

An AI ETF is a fund that owns a portfolio of stocks that generate a meaningful amount of their business via direct involvement in creating, producing and disseminating AI hardware, systems and platforms.

All investors, from venture capitalists to individuals who buy and sell stocks and ETFs, need to be aware of the risks associated with investing in AI.

One of the major concerns about such a young (from a mainstream perspective) and controversial space is that the rules are currently being written and rewritten around data protection, privacy and copyright, among other regulatory, consumer and sociocultural issues. If the results of AI-related lawsuits or government legislation places tight restrictions around AI, it could affect demand, which could hurt companies that derive a significant portion of their revenue from AI.

Also, while mainstream adoption seems inevitable, AI might not become as big as previously thought. At the same time, with things moving so fast, technology that seems relevant today could be obsolete tomorrow. Thus, the focus on perennial tech leaders rather than companies that claim to be pure plays on AI. And, of course, when it comes to stocks, specifically tech stocks, there is likely to be volatility around stock prices. Just as top tech stocks often lead bull markets, they sometimes drop significantly during down trading days, corrections and sustained bear markets.

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