Worried About the AI Bubble? How to Stay Invested in Stocks Without Getting Burned.

(Illustration by Barron’s; Dreamstime (2))

The artificial intelligence boom has lifted tech stocks again this year, helping push the S&P 500 to new heights. If investors turn out to be overly optimistic about AI, the index could underperform for years.

Suppose you want to protect yourself from a frothy market, but want to stay in stocks. Whether you’re a young worker or a new retiree, you still may want the higher returns that stocks generally deliver over decades compared with bonds. Consider spreading your equity chips more broadly on the table.

A lot of financial advisors routinely do this, reducing holdings in the S&P 500 or tech-focused investments and putting the gains in value stocks, small-caps, and international shares. “We want to keep trimming profits and putting that profit money into things that haven’t done as well,” says Susan Elser, a financial advisor in Indianapolis.

By contrast, individual investors managing their own brokerage accounts or 401(k) portfolios often let money accumulate in top-performing funds. As a result, many are overweight in the S&P 500 index, and will be stung hard if the index tumbles hard or even if it lags behind the broader market for years.

Whereas younger investors can easily weather market drops, they are devastating to seniors at the beginning of their retirement. They could be forced to sell depleted stocks to fund their spending. Their portfolio might never recover.

“If you’re retired, you have to ask yourself, ‘What kind of risk am I taking with stocks’,” says money manager William Bernstein, author of The Four Pillars of Investing: Lessons for Building a Winning Portfolio. “If your stocks don’t do well, you may be eating cat food.”

Professional money managers tend to be more disciplined about rebalancing their stocks, even if it lowers their returns in the short term. Jonathan Harrison, a financial advisor at Sound Stewardship in Overland Park, Kan., has been overweighting large-cap value, small-caps, and international stocks in his client portfolios for years. He also keeps about 5% of portfolios in gold, which had languished for years before a recent rally.

Clients didn’t like it in the past when Harrison sold hot-performing technology stocks to buy sectors with slower gains and lower valuations. It paid off this year when international stocks soared, the dollar sank, and gold prices rocketed up nearly 60%. “I’m investing over the long term,” he says. “Not what stocks do over the next 12 to 24 months.”

Elser, the Indianapolis advisor, builds client portfolios with a value tilt. The equity portion currently includes these funds and allocations: the Vanguard S&P 500 exchange-traded fund , 3%; Dimensional US Core Equity Market, 28.9%; Dimensional US High Probability, 10%; Dimensional US Marketwide Value, 8.4%; Dimensional U.S. Small Cap, 5%; Dimensional US Small Cap Value, 11%; Dimensional International Core Equity 2, 21.1%; Dimensional Emerging Markets Core Equity 2; 10.6%; and Dimensional Global Real Estate, 2%.

Created with Highcharts 9.0.1A simple way to reduce exposure to U.S.​tech is to opt for a global fund.Source: FactSet

Created with Highcharts 9.0.1Vanguard S&P 500 ETFVanguard Total World Stock ETF2023'25-250255075100%

Elser has reduced her holdings in highflying tech stocks, but she hasn’t fled. The Magnificent Seven companies— Nvidia , Microsoft, Apple, Amazon.com, Alphabet, Meta Platforms , and Tesla —account for about 21% of equities in her portfolios. By contrast, they account for roughly 34% of the S&P 500 index.

While money managers often use multiple funds for their investors to diversify risk and regularly rebalance, there is a simpler way of lessening your dependence on highflying U.S. tech stocks in the S&P 500. Buy a global fund instead of an S&P 500 fund.

That is what financial advisor Ajay Kaisth of Princeton, N.J., does with young investors who are starting out. He puts the entire investment in a global exchange-traded fund like the Vanguard Total World Stock ETF. Currently, the S&P 500 represents about half the valuation of a global fund, so investors will partly share in its gains but won’t get hit as hard if it plummets.

“It’s a very efficient, simple way of getting exposure,” he says. “It’s particularly powerful in cases where I have opened Roth IRAs” for the clients, so all future gains will be tax-free.

Write to Neal Templin at neal.templin@barrons.com