Investing in AI without being burst by the bubble

Investing AI without being burst by the bubble | freshidea - stock.adobe.com

In the world of investment, one of the defining themes in the last year has been the unrelenting rise of AI. So, it is little surprise that AI is having a huge impact on the global stock market in particular.

The big question now is whether the AI bubble has grown too large, too quickly, and if it’s about to burst? AI company valuations have soared dramatically, often detached from current profitability or proven business transformation. A key red flag is the sheer scale and speed of investment: AI-related companies including the ‘Magnificent Seven’ - Nvidia, Microsoft, Apple, Alphabet, Amazon, Meta, and Tesla - have driven up to 80% of US stock market gains this year, according to data from Bloomberg, Meanwhile, institutions including the Bank of England and the IMF signal that inflated AI stock prices, fuelled by hype and speculative investments, could abruptly correct, potentially resulting in a sharp market crash affecting the broader economy.

So clever investors are right to ask ‘is the AI party about to come to an abrupt end?’

Have we seen a bubble like this before?

History suggests there are serious parallels between the current AI boom and what was coined the dot-com bubble of the late 90s. Coinciding with the explosion of the World Wide Web, a number of companies, and especially start-up businesses, rode the wave of excitement around the new technology and soared in value. Company valuations then came crashing down to earth in 2000 as investors caught wind of the shaky finances of many of the ‘dot-com’ companies, and quickly re-deployed capital elsewhere.

The current AI bubble looks to have stronger foundations than the dot-com bubble, but it is subject to different threats. The sector is subject to a fragile global supply chain which provides the components required to develop chips and processors. Taiwan produces 90% of the world’s semiconductors, yet falls under the threat of invasion from China for example. A rupture in the supply chain would be catastrophic for the AI industry.

How can DIY investors protect themselves from any potential market fall, while also benefitting from the AI boom?

The current conundrum for investors is a tricky one: benefitting from the rise of AI as a technology, while avoiding getting overexposed and risking everything should we see the bubble burst. There are two key things to bear in mind.

The most important advice for investors here is to look to diversify their portfolio. While it’s easy to be tempted to go all-in on AI companies such as Nvidia, given historic trends of growth, at a time when valuations are so high it’s extremely important to protect investments by spreading them across sectors and asset classes.

It’s also important to consider the best entry-point when investing in AI. While the market has been on the rise generally, there have been periods of market correction where valuations of key AI stocks have fallen. These are the best times to invest. The key is to keep a close eye on the markets and do your homework on which AI-related stocks you want to invest in, so that when these fallow periods occur you are poised to take advantage and invest.