Cathie Wood says there will be a ‘Reality Check’ for artificial intelligence (AI) investors. Here are 3 things smart investors need to know.

By | March 31, 2024

Cathie Wood, CEO of Ark Invest, is known for her strong commitment to emerging technology trends. With artificial intelligence (AI) taking center stage as the next big thing in technology investing, Wood makes her views clear.

In a shareholder letter published earlier this month, Wood proclaimed that a “reality check” could be in store for AI investors. I think she’s right.

Let’s address Wood’s concerns and assess how AI euphoria is fueling broader trends in capital markets. While there are some underlying risks, investors don’t need to panic. I see many ways to benefit from the AI ​​revolution, as long as sensible financial judgment is applied.

The fever pitch of artificial intelligence

After a dismal performance in 2022, shares recovered sharply last year. The tech heavy Nasdaq Composite The index rose by 43%, mainly due to positive sentiment around the AI ​​story.

The euphoria has continued into 2024, both on the Nasdaq and on the stock exchange S&P500 have reached and eclipsed new record levels this year. The upward momentum shows no sign of slowing down, which may leave investors thinking that all things AI is a good area to invest your money.

Not so fast! Let’s take a deeper look under the hood.

A pink model rocket with a rising line above a bar graph.A pink model rocket with a rising line above a bar graph.

Image source: Getty Images.

Less is more

The chart below illustrates 2023 returns for the ‘Magnificent Seven’ stocks – a name used to scoop up mega-cap tech companies Microsoft, Apple, Nvidia, Alphabet, Amazon, MetaplatformsAnd Tesla.

NVDA graphNVDA graph

NVDA graph

It’s easy to see that this small cohort of stocks generated eye-popping gains. But considering the S&P 500 returned a total of 24% in 2023, there’s something more curious going on here.

Essentially, the Magnificent Seven played a major role in the rise of the S&P 500 and Nasdaq last year. Another way to look at this is that most of the stocks in these indexes either underperformed the broader market or did not rise at levels comparable to the Magnificent Seven.

Look for proven winners

Every now and then new terminology enters the regular investment lexicon. Over the past decade, terms like “metaverse” and “blockchain” have each seen fleeting popularity. I would say AI is on the verge of the same trend.

This dynamic entails many risks when it comes to investing. Things can become difficult if investors opt for thematic investing.

On the surface, investing in broader market themes through exchange-traded funds (ETFs) or other passive vehicles seems harmless. However, sometimes investors will bypass index funds and try to identify the ‘next big thing’ themselves. This can be problematic because investors often connect dots that aren’t really there and blindly take a position in a speculative company that rides the current wave.

Artificial intelligence is clearly the biggest theme driving investment in technology at the moment. Given the amount of money being poured into anything remotely related to AI, it makes sense that some stocks will benefit from long-term trends rather than proven business results.

In other words, many tech stocks are rising for the wrong reasons. Following the hype often comes with risks and can leave you as a bag holder when the music inevitably stops playing.

While there are some real winners in AI, the chart above suggests that the best investments may be a small set. Of course, there are plenty of options besides megacap technology.

Overall, I think Wood is right when he says that a lot of capital has been poured into AI, but only a small portion of it will pay off. If you are interested in artificial intelligence exposure for your portfolio, I recommend looking into passive funds with diversified investments. Alternatively, you can also take equal positions on the biggest, most proven players in the space and track performance accordingly.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, former director of market development and spokeswoman for Facebook and sister of Mark Zuckerberg, CEO of Meta Platforms, is a member of The Motley Fool’s board of directors. Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Adam Spatacco has positions in Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla. The Motley Fool holds positions in and recommends Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla. The Motley Fool recommends the following options: long January 2026 $395 calls to Microsoft and short January 2026 $405 calls to Microsoft. The Motley Fool has a disclosure policy.

Cathie Wood says there will be a ‘Reality Check’ for artificial intelligence (AI) investors. Here are 3 things smart investors need to know. was originally published by The Motley Fool

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