AI or Black Eye: Choose Your Weapons Steve Abramowitz

“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.