Ask the expert: How should I invest if I’m worried about an AI bubble?
Fidelity personal finance specialist Marianna Hunt is back on hand to answer your burning questions. This week Marianna helps a reader who is fearful of a potential tech-fuelled stock market crash.
Q:I’ve built up reasonable savings in my ISA, workplace pension and SIPP. Most of my investments are in global index funds, so I’m heavily exposed to big tech companies in the US. I’ve been reading reports that we could be in an AI bubble which, if it bursts, could lead to a market crash. That could put a big dent in my savings.
Should I be thinking about changing my investments? If so, what should I be investing in instead?
A: This is a question that many investors are asking themselves currently.
You are right that the hype around AI has caused valuations of big tech companies to soar to unprecedented heights. Many experts are questioning whether these valuations are justified, particularly if the technology transformation does not deliver all it promises.
Global index funds (funds that passively track the performance of markets as a whole) are particularly vulnerable to this possibility.
That’s because they allocate money to companies based on their stock market value, so money disproportionately flows into bigger, more valuable companies – like the Magnificent Seven tech stocks.
As of mid-February, the Magnificent Seven made up more than 30 per cent of the S&P 500 (an index comprising 500 of American’s biggest companies).
But should you do something about it?
How much risk are you willing to take?
The question will depend on how much risk you’re comfortable taking and what your time frame is for these investments.
If you have decades before you plan to cash these savings in, you may well choose to do nothing. The stock market tends to bounce up and down, sometimes quite dramatically, and yet the long-term trend has been upwards.
Even someone who invested in a global tracker fund at the peak of the dotcom bubble in 2000 would have seen their money recover within about six to seven years and, by now, their portfolio would now be worth more than six times what they invested.
This is based on total returns and assumes they reinvested their dividends, although, of course, past performance is no guarantee of the future.
Many (including the professionals) have attempted to “time the market” before and failed, and, once you sell your investments, it can be very hard to know when the right time is to buy back in.
However, if you are close to accessing this money, you do not have the benefit of time to wait for a potential recovery. In that case, you will probably be looking to take less risk and protect the value of your nest egg.
Even if you do have plenty of time on your side, you may not have the stomach to tolerate the risks of remaining so heavily invested in expensive tech stocks, and that is perfectly reasonable.
The good news is there are plenty of other areas of stock markets that are much cheaper and are less exposed to the whims of AI.
Other investment possibilities
One option could be to invest in income-paying companies. A stock that pays an income tends to have reached a certain level of maturity and to be managed in a way to maintain its profits and therefore the income it pays (company executives hate to cut dividends).
This can make income stocks more stable than the market average, although that’s never guaranteed. On top of that, the US stock market has a low yield, so income funds tend to invest in other markets, such as the UK, which are more moderately valued than Wall Street.
Although there is no guarantee that, in the event of a severe fall in America, other markets would not suffer, prices of resilient income stocks could be expected to fare better and recover sooner.
Popular income funds with Fidelity customers include Ninety One Diversified Income, and ClearBridge UK Equity Income.
Another option could be to switch from passive index funds to active funds. These are managed by professionals who, rather than tracking the market, try to select a few specific companies they think will do better than the rest.
Look away from the Mag Seven
If you’re worried about AI, look for ones that do not hold the Magnificent Seven in their top 10 stocks, such as Fidelity Special Situations.
This fund focuses on investing in companies the manager believes have been overlooked by other investors. Much of the portfolio is in the UK.
That raises another point: you could look to move money into other, cheaper markets than the US, such as the UK, China and emerging markets.
You could do this via an active or a passive fund depending on your preference. These markets do come with their own risks, so it’s important to do your own research.
Finally, if you want to stick with global index funds, you could look for ones that hold ‘equal weights’ of every constituent, rather than the usual practice of sizing holdings in proportion to the value of each stock.
This avoids the problem of concentration in a small number of companies. These including the Legal & General S&P 500 US Equal Weight Index Fund and the Invesco MSCI World Equal Weight ETF.
Please remember that this is not financial advice. Every person’s situation is unique, and, in many cases, it would be valuable to speak to a qualified financial adviser.
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