How to invest in AI? Investment strategies for the next generation

Every investor dreams of getting in early on the next transformative trend, and right now, that trend is artificial intelligence (AI). 

Investing in AI today mirrors the decisions faced by investors in the late 1800s when the railroad industry was booming. Back then, investors had the option to purchase stocks in railroad companies directly or to invest in businesses that thrived because of the railroads, such as textile manufacturers and meat processors, which benefited from faster and cheaper transportation of their goods.

One of the main challenges in investing in AI is the scarcity of pure-play AI companies available on the market. Unlike industries with numerous dedicated firms, the AI sector is still developing, making it difficult to find straightforward investment opportunities. To navigate this landscape, it’s essential to explore various ways to invest in companies and funds that are capitalizing on the AI revolution.

This could include investing in tech giants that are heavily investing in AI research and development, as well as in startups focused on innovative AI applications. Additionally, looking into exchange-traded funds (ETFs) that target AI and machine learning technologies can provide a diversified approach, allowing investors to benefit from the growth of the entire sector rather than relying on individual stocks.

As AI continues to evolve and integrate into various industries, savvy investors should consider a multi-faceted strategy to seize opportunities across the landscape. By doing thorough research and staying informed about emerging trends, investors can position themselves advantageously in this rapidly growing field.

Understanding AI: What it is and why it's gaining popularity

IBM defines artificial intelligence (AI) as the use of computers, machines, and software to replicate the problem-solving and decision-making abilities of the human mind. The primary objective of AI applications is to enhance problem-solving speed and automate tasks traditionally performed by humans.

The surge in interest surrounding AI began in November 2022 with the public release of ChatGPT by OpenAI. This chatbot utilizes natural language processing to engage users in human-like conversations, allowing them to ask questions on a wide range of topics and receive detailed responses.

However, ChatGPT is just the latest chapter in the history of AI, a field that has experienced fluctuating interest since the 1950s. 

“It’s important to note that AI is not a new concept,” explains Michael Robbins, a board member at private equity firm Blythestone and London hedge fund UEC. “The recent hype around ChatGPT reflects a growing understanding of AI’s potential impact on the economy.”

The term "artificial intelligence" was first introduced in 1956 by John McCarthy of MIT and Marvin Minsky of Carnegie Mellon University during the Dartmouth Summer Research Project on Artificial Intelligence, where they aimed to lay the groundwork for the field.

Fast forward to today, analysts at PricewaterhouseCoopers estimate that AI innovations could increase global GDP by as much as 14% by 2030. Such growth positions AI as potentially “the biggest commercial opportunity in today’s rapidly evolving economy,” according to PwC.

How to invest in AI: Strategies and options

Investing in artificial intelligence (AI) can take several forms today. You can purchase stocks of public companies that develop AI software or manufacture the hardware essential for running AI applications. Alternatively, there are emerging exchange-traded funds (ETFs) that focus on investing in companies involved in AI.

Investing in companies benefiting from AI

While buying individual stocks carries more risk than owning diversified funds, it can also offer potentially higher returns if you’re comfortable with that risk. Here are three standout AI stocks to consider:

Microsoft (MSFT): CEO Satya Nadella has emphasized that Microsoft is fully committed to AI. The company has partnered with OpenAI to integrate ChatGPT into its Bing search engine and is incorporating AI into Microsoft 365 to enhance productivity features. Year-to-date, MSFT shares have risen over 40%.

Nvidia (NVDA): Known for its semiconductor innovations, Nvidia has seen tremendous success with its chips, which are crucial for applications ranging from 3D graphics to cryptocurrency mining. Its chips are now in high demand for running advanced AI algorithms, with shares soaring more than 200% this year.

C3.ai (AI): This pure-play AI company focuses solely on implementing AI solutions across various industries. Clients include major companies like Shell and the U.S. State Department. C3.ai's shares have skyrocketed over 250% year-to-date, though it's important to note that the stock is still 70% below its 2020 peak.

Should you buy AI stocks?

While Microsoft, Nvidia, and C3.ai have shown significant gains, investing in these stocks may not be suitable for everyone at this time. Key considerations include:

• Rising valuations: AI stocks have become more expensive, making their valuations less appealing. As of mid-July, a basket of AI stocks was up 42% for the year, compared to a 25% rise in the broader technology sector.
• Potential for short-term pullbacks: Experts like Michael Robbins suggest that AI stocks could experience a downturn as they take a breather from their recent gains.
• Future winners: Many current successful AI stocks are large-cap companies, but history suggests that smaller, agile growth stocks are often better positioned to innovate and capitalize on new opportunities.

Investing in AI Exchange-Traded Funds (ETFs)

For a lower-risk approach, consider investing in AI-themed ETFs. These funds offer diversification and are gaining traction among investors. In 2023, inflows into AI ETFs increased by over 70%, in contrast to a mere 2% gain for all U.S.-listed stock ETFs.

Currently, there are 17 U.S. ETFs focusing on AI or machine learning. Here are four of the top-performing AI ETFs over the past year:

• Direxion Robotics, Artificial Intelligence & Automation Index Bull 2X Shares (UBOT): This leveraged ETF aims to achieve twice the daily return of the Global Robotics and Artificial Intelligence Thematic Index. It invests in developed companies expected to benefit from robotics and AI, with a 1.35% annual expense ratio.
• Global X Robotics & Artificial Intelligence ETF (BOTZ): An unleveraged counterpart to UBOT, BOTZ tracks the same index but offers returns approximately half that of UBOT. Its top holdings align closely with those of UBOT.
• Franklin Intelligent Machines (IQM): This ETF targets a broader range of companies, focusing on those developing technologies that support AI and automation. Its top holdings include major players like Tesla and Apple.
• AIQ Artificial Intelligence & Technology (AIQ): This ETF invests in a diverse array of AI innovators, regardless of sector or geography, featuring companies such as Meta Platforms and Salesforce.

By exploring these investment avenues, you can position yourself to benefit from the growth and potential of the AI sector.

The thrill of investing in AI: Caution and considerations

Investing in a groundbreaking technology trend like AI can be both thrilling and potentially lucrative. However, it's essential to remember that, like any investment in the stock market, AI is influenced by the hype cycle.

New technological advancements often spark the creation of dynamic companies and extensive media coverage, driving stock prices to new heights. However, these extraordinary gains are rarely sustainable; eventually, the market distinguishes a few winners from many losers, and overly optimistic investors can find themselves at a loss.

If you're thinking about investing in AI, your first step should be thorough research. Educate yourself about the technology and assess the associated risks before making any purchases. There’s no need to invest everything in AI; wise investors prioritize diversification to maximize their investment potential. It may also be beneficial to discuss your AI investment strategies with a financial advisor.