The US Magnificent Seven stocks of Apple, Nvidia, Meta, Microsoft, Tesla, Alphabet, and Amazon have become synonymous with the artificial intelligence (AI) megatrend.
All seven companies are using advanced technology, including AI, in some form or another.
Nvidia makes the chips that enable AI to work. The others are using AI to enhance their product and service offerings and grow their productivity.
The Mag 7 are the first movers in AI and are taking advantage of its benefits well before mainstream businesses have even figured out how AI might apply to them.
So, it's only natural that investors have flocked to these US stocks in recent years, pushing their share prices up exponentially.
The Mag Seven's valuations have risen so high that these seven stocks now comprise about 32.5% of the S&P 500 Index (SP: .INX).
As we've recently reported, that creates some concentration risk.
Vanguard Global Chief Economist Joe Davis says there is a better way to invest in AI with less risk. And it's very simple.
How to invest in AI with less risk
In a recent blog, Davis said the market should look beyond the tech sector and individual companies such as the Mag 7 that are providing AI hardware or services.
He points out that AI is a revolutionary change that will seep into every market sector over time as companies figure out how to use it to raise their general productivity.
So, in essence, pretty much every business in the world will benefit from AI in some way over time. And that's why investors should simply buy the S&P 500 Index to gain exposure to it.
Davis says:
Our research, perhaps surprisingly, does not suggest that you should overweight tech stocks.
If an investor is looking to take advantage of the growth predicted by the evolution of AI, the first order of business is to overweight the broad equity market—the U.S. equity market.
I say the U.S. equity market because that's where the strength of the growth will likely be given the vibrant source of innovation that the U.S. economy has been and seems likely to continue to be.
Davis points out that US tech stocks "in general are very highly valued currently—much of that potential upside is already priced in".
He also says the tech sector, as a whole, has not historically outperformed during periods of technological transformation.
We'd expect some future stars to emerge, but there will be a larger percentage of those in the sector that flop.
For every Amazon that emerged from the internet bubble, there were dozens of start-ups that failed.
Davis said AI will likely be transformative in many other sectors, including healthcare, finance, and manufacturing.
He observes that many US companies in these sectors "are considered value stocks in the current market environment", so investors can buy in at a reasonable price now.
Davis likens AI's transformative power to that of electricity. Over the long term, it will impact all businesses, driving higher growth and productivity across the broader economy.
Therefore, Davis said investors should not focus their investments solely on the tech sector nor a concentration of stocks, such as the Magnificent Seven.
When it comes to the stock market, two seemingly contradictory statements can both be true.
On one hand, large-cap (generally growth) stocks have a lot of staying power for longer than some might think—so the concentration could continue.
On the other hand, these enterprises generally do not hold onto their position and growth mode for more than a few decades.
Look at a list of the largest S&P 500 members from a few decades ago and compare that to today. Similarly, where were most of the Magnificent 7 stocks just 20 years ago?
The simplest way for investors to navigate the AI revolution is to "own the total stock market" with a broadly diversified index fund, Davis suggests.
Another way is for the investors with active risk tolerance to work with active managers who can spot the decadal sea change and identify spectacular winners for the coming decade early on.
