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“There’s been a lot of talk
about an AI bubble. From our
vantage point, we see something
very different.”
Jensen Huang, CEO Nvidia
“No company is going to be immune
(if the AI bubble bursts), including us.”
Sundar Pichai, CEO Google (now known as Alphabet)
Is the AI revolution a blessing or a curse, an enduring breakthrough or impending economic and cultural apocalypse? Many investors have taken a position and chosen their weapons, with some wielding funds dedicated to AI and others brandishing funds that minimize exposure to it. At this juncture, we don’t know if the prices of stocks heavily dependent on artificial intelligence are too high, about right or perhaps even underestimating its power.
My aim here is neither to glorify nor vilify readers with large stakes in AI. And it’s certainly not to advocate an oversized role for AI in long-range financial planning for retirement or college education. Efficient broad market index funds—most now already tilted towards AI—are consensually regarded as the vehicle of choice for those objectives. We are talking here about investing for shorter-term purposes, such as helping to offset a brief encounter with sequence of returns risk.
A caveat at the outset. I have elected to use exchange-traded funds (ETFs) rather than index funds for this analysis and discussion. Oh, I know that most AI readers prefer (even demand) passive investing within the tried-and-true mutual fund structure and that Humble Dollar espouses the Boglehead philosophy.
But I am also aware the asset flows are fast turning towards the upstart ETF. Since 2011, almost 150 mutual funds have converted to corresponding ETFs and the pace of the desertions is accelerating. In 2024 mutual funds bled over 150 billion in investor money, when ETF assets soared to over 1.1 trillion. While the oft-demonstrated efficiency of the index fund has offered much shelter from this tsunami, it is undeniable that the traditional mutual fund is fast becoming extinct.
Though the index fund boasts several of the advantages of the ETF (instant diversification, low cost, transparency and incidental capital gains), it lacks the game-changer. Index funds can only be transacted at the closing price, whereas ETFs can be traded any time during the day just like a stock. To be sure, many skeptics (starting with Bogle) have warned that this ease of trading is actually a double-edged sword. For the impulsive investor or the person who craves action, this feature of the ETF could well foster overtrading or sheer speculation.
With that ado, let’s take a close look at two AI-oriented ETFs. The first is a dedicated offering (Global X Artificial Intelligence and Technology: AIQ) and another (Defiance Large Cap Ex-Mag 7: XMAG) whose mandate greatly reduces the influence of AI on its results.
Global X Artificial Intelligence and Technology ETF
You may be wondering who these Global X characters are and is the outfit legit. The management group is a leading provider of thematic ETFs with over 76 billion in assets spread across 90 stocks. Not surprisingly, three of its top five holdings are members of the vaunted Magnificent 7 (Google now Alphabet, Apple and Tesla). Top ten holdings include other prominent domestic AI stocks (like Advanced Micro Devices) and several likeminded companies from overseas (Taiwan Semiconductor Manufacturing).
Let’s be fair now. This Global X ETF is highly volatile. It lost a whopping 36% during the technology bloodbath of 2022, but catapulted an eye-popping 79% over the next two years. What about this year? AIQ is up yet another 34%, a full 10% more than the popular Vanguard Information Technology ETF (VGT).
But you have to pay to play–the concentrated AI fund is also very expensive. Its .68 cost will strike many readers as prohibitive if not downright laughable, especially when weighed against the Vanguard offering’s tailored .09. Keep in mind, though, that restricting deployment of the fund to short-term objectives renders the stark cost difference less destructive.
Defiance Large Cap Ex-Mag 7 ETF
But what if the enthusiasm and momentum of AI turn out to be overblown? Could the massive indebtedness incurred by AI-dominant companies to fund their capital expenditures prove disastrous to individuals overinvested in them?
Enter Defiance, a young ETF provider with a budding reputation for filling overlooked thematic needs in the fund marketplace. The firm has 7 billion in assets, a baby in the fund industry. But it has issued one ETF particularly relevant to this conversation: the Defiance Large Cap Ex-Mag 7 (XMAG). The 98 million fund is designed to give investors the opportunity to own the S&P 500 absent the Magnificent 7, the heavyweights in the AI competition (Google now known as Alphabet, Amazon, Apple, Facebook now known as Meta, Microsoft, Nvidia and Tesla). Because just these seven stocks comprise fully one-third of the S&P, XMAG is far more diversified than Vanguard’s gigantic S&P 500 ETF (VOO). At .35, expenses are modest for a relatively new thematic fund.
As an aside, the Defiance ETF and others with a similar goal may help to elude an unlucky sequence of returns during the period spanning late accumulation and early withdrawal of your retirement assets. With XMAG, retirees have the peace of mind in knowing their nest egg is not unsteadied by the fortunes of just seven highly correlated AI-infused technology stocks.
Two footnotes. I know full well the message of this article runs counter to the spirit of Humble Dollar, but it is what it is. The discussion is offered for educational purposes only and should not be construed as investment advice. You should consider your own financial situation and risk tolerance and if advisable consult a professional before you invest. In the interest of full disclosure, the author has a 12% position in AIQ and none in XMAG.
Haven’t seen you here lately, Steve, hope you’re well.
Not sure why you posted this, though, when you say yourself that it’s “counter to the spirit of Humble Dollar”. However, if you actually want a concentrated AI ETF, why pay 0.68%? You can buy Vanguard’s Mega Cap Growth ETF for 0.07%. Personally, I’m sticking with boring old mutual funds, only 50% stock and diversified. I moved money out of the S&P500 fund to Extended Market and International when I rebalanced in October.
Hi My Time To Travel,
Thank you for your concern. Good to know somebody remembered me! I’m touched. I wish
you well, too.
I’m doing pretty well, in a kind of a (thankful) bubble of good functioning at 80.
At first you your post scared the hell out of me—because I thought you were right! But after checking info from Vanguard and Morningstar I feel vindicated and here’s why:
The two funds produced markedly different returns for the year, 21% for MGK and 34% for AIQ. This would be expected since AIQ focuses on ted hot AI, whereas MGK has a much broader mandate. (To be fair, AIQ is slightly more volatile.) And if AI tanks, so of course would AIQ.
More of a quibble than anything else, MGK as a growth fund is particularly light on large cap value, small caps and international, but as you say you’ve got foreign stocks covered and I suspect small stocks and value as well.
Well, that’s my rejoinder, hopefully more informational and helpful than critical.
Glad you’re still doing well. I’m fine, and enjoying my CCRC. I have no interest in owning MGK, but you should know that Vanguard also has a Mega Cap Value ETF, and a plain Mega Cap ETF.
According to the WSJ, Open AI pays out over 45% of its revenues to its employees with an average annual total compensation of $1.5M.
Heady times.
Loved the article, thanks Steve. As an indexer, this stuff fascinates me because it’s way outside my Overton Window.. Or is it?..
100% of my Roth is VTI (the whole US enchilada). Hoping my wife and I never have to touch it and the kids get it. About half of my taxable equities are in VOO (the S&P 500).
Thus my largest holdings are AI or AI adjacent. I just made this GIF that transitions between these two funds and their top 10 holdings are virtually identical. Swingin’ for the fence. Data from Yahoo.
I don’t know what’s in the other half of your taxable holdings, but it looks like you may have a 25-30% AI-dominant tech position. Not reckless, but quite aggressive. It sounds though like you may have enough liquid assets to cover you if Mr. Market throws you a curveball!
I expect that curveball soon. Maybe a 10% off sale, maybe more. It’s been a fun 45 years except when it wasn’t. You are so right about the liquid assets, mainly VMFXX in my case.
I wish I had your risk-tolerance!
My plan is in the second week of January to go 70% VT (Vanguard Total World) and 30% VTV ( Vanguard Total Value). This will lessen my exposure to the Mag 7 but still be 100% in stocks
LH,
A nice twist, plus you get a meaningful international stake. According to Morningstar, VT is about 25% high tech. Assuming VTV has no significant AI exposure, I think you will have reduced your AI position to around 17%. Just another confirmation of where everybody seems to be comfortable!
Thanks for the input. One of the things I appreciate about HD is every comment is thought provoking, either challenging my plan or affirming it
Thank you. We owe it all to the guy who put the site together, ran it and made it a community of people interested in sharing their financial concerns and some remedies.
Good to hear from you, Steve, thanks for this timely discussion. I’m comfortable with a 65/35 asset mix, still, I don’t need to hit home-runs at this stage of my life. Limiting my exposure to AI while maintaining that mix seems prudent at this time.
Agreed!
Wow, these first three comments are all singing the same song: at our age, wisest to limit but not necessarily fully dispense with AI.
Seems like a sensible play to me. I’ve nothing against a bit of AI concentration risk, but on my terms and at my sleep-easy-at-night level, which is 15% of my equity portfolio, not the 25-30% you’d get from a total market index. If others want to stick dogmatically to a total market portfolio, that’s their choice, but that level of concentration risk isn’t to my taste. In essence, I want some AI exposure, but not at the level Mr. Market is currently force-feeding index investors.
I’ve taken a different approach to reducing Mag 7 concentration through increased international diversification rather than a specialized US fund. By adding more European, Asian, and UK holdings, I’ve brought my Mag 7 exposure down to a still significant 15% of my equity portfolio. I feel this offers geographic diversification across different economies and currencies at lower costs than thematic ETFs.
As someone in early retirement, I don’t need to chase the higher potential returns of a Mag 7-heavy portfolio, I’ve already won the game. I don’t need to play. It sacrifices some potential upside if the Mag 7 continues its dominance, but that’s the trade-off for meaningful risk reduction. Protecting what I have with smaller gains matters more than maximizing gains with the higher risk profile
.
Similar approach here, Mark. Using a Total Market fund instead of S&P 500 for US exposure which reduces Mag 7 concentration a bit (but not much) but then goosed the international allocation to over 35% of total equity which makes my Mag 7 exposure about 16% and much less after factoring in the fixed income piece of our portfolio. Saw this quote somewhere recently – “You make money with concentrated asset allocations but you keep money with diversified asset allocations.” I’m definitely in the “keep money” age group.
I’ve seen a similar quote: “Concentration builds wealth, diversification preserves it.” I think these sayings reflect collective wisdom, and I’m comfortable acting on the common sense embedded in them.
Mark,
Wow, how unusual is this—everyone is in AI between 15-22% (sometimes even more diluted by the fixed income allocation). In another vein, I think it’s pretty rare that a holder of a total market fund recognizes that its tech concentration isn’t much below what it is for the S&P.
I’m gifted! 😉