AI nerves reinforce age-old investing lesson: Get diversified

A $2.5 trillion wipeout for the Nasdaq Composite this week is reminding even the smallest investors just how reliant we’ve all become on the success of the artificial intelligence buildout.

As AI stocks tumbled Thursday, the major indexes dropped sharply, with the Dow, S&P 500 and Nasdaq each posting their worst day in 19 months. The Democrat sweep in the midterm elections is accelerating concerns that moratoriums and other public policy hurdles could slow the pace of AI data center construction.

The recent volatility is unnerving, but it reinforces the importance of diversification: Investing in a mix of stocks, bonds, commodities and other assets can help make sure a portfolio isn’t too reliant on a few blockbuster stocks — and can help you weather rough times.

Many portfolios and 401(k)s became increasingly AI-heavy as tech companies’ market values surged and grew to comprise larger portions of benchmark indexes like the S&P 500.

The recent tech-driven selloff “is a wake-up call for investors who may have drifted away from a well-diversified portfolio,” Arun Sundaram, senior vice president for investment strategy at CFRA Research, told CNN.

That wake-up call means it’s time for investors to put in some work to ensure they are diversified.

AI everywhere

Over the past four years, AI has become the dominant force in the stock market, boosting the share prices of technology companies, semiconductor chipmakers and other businesses involved in the data center buildout.

Chipmakers make up nearly one-fifth of the S&P 500’s market value. The top 10 stocks in the index — nine of which are tech stocks — account for almost 40% of the index’s market value. As tech stocks have soared in recent years, major indexes like the S&P 500 have become more concentrated, which can make it feel harder to diversify.

The AI boom sent the S&P 500 soaring 88% between November 2022 — when OpenAI unveiled ChatGPT for public use — and Thursday’s rout, lifting the value of portfolios and 401(k)s. Since AI supercharged much of the index’s gains, many portfolios are now heavily exposed to AI and underprepared if there were ever a severe decline in stocks tied to the buildout.

Seeing a lot of red in your portfolio can be unsettling, but it’s essential to remain calm and avoid selling in panic, portfolio managers said. It’s important to be disciplined about how you take action.

How to diversify

There’s no one-size-fits-all strategy for investing, and it largely depends on your age, time horizon and risk tolerance.

Trying to find the best time to buy and sell is considered a fool’s errand. Rather, investors can use different strategies so their portfolio is better diversified in the long run.

Investing in health care stocks, long-term bonds or buying specific exchange-traded funds can be a good bet when there are concerns about AI stocks declining, said David Bailin, founder and chief executive officer at the CIO Group.

Health care is one sector that can fare well regardless of what happens with AI. The bond market sell-off in recent months pushed yields upward to relatively attractive levels that can provide strong long-term income for investors. Bailin said he also likes active futures funds, which provide exposure to investing strategies that try to maintain a low correlation with stocks and bonds. That can help balance out losses when stocks decline.

Investors can be hesitant to dig into the weeds of their portfolio, but it’s critical to be proactive and to make sure you’re aware of what you hold, especially after such a strong run for tech stocks in recent years.

“Be mindful of the hidden concentrations in portfolios,” Bailin told CNN. “You can do something about them.”

Investors should be careful not to dump all their AI stocks. Tech stocks are high-growth stocks when times are good, contributing strong returns to portfolios. But investors should be thinking about how to hedge against their exposure by investing in industries that have less correlation to AI, like health care and consumer staples.

“Diversification doesn’t eliminate losses, but it reduces the extent to which a financial plan depends on any one part of the market,” said Tomas Geoghegan, founder at Beacon Hill Private Wealth.

Ultimately, make sure you are comfortable with what’s in your portfolio and that it matches your risk tolerance and lifestyle goals. Investing in commodities like gold, high-quality bonds and cash equivalents can also provide diversification.

“Diversification allows investors to feel more comfortable that their portfolios can weather volatility,” said Erin Kolo, manager of PWM equity and fixed income research at Baird.