Investing in Artificial Intelligence (AI) Stocks Can Be Risky, but Here's a Magnificent Way to Do It

The sun is setting on 2023, and just about every investor will agree that artificial intelligence (AI) was the theme of the year in the stock market.

It carried tech giants like Nvidia and Microsoft to record-high stock prices. Many smaller AI stocks have also logged huge gains this year, but they remain far below their best-ever levels:

• Palantir Technologies is up 174% in 2023, but down 50% from its all-time high.
• C3.ai is up 166% in 2023, but down 81% from its all-time high.
• Lemonade is up 26% in 2023, but down 89% from its all-time high.

This highlights the difficulty of picking winners in a brand-new industry like AI. Nobody knows how this technological revolution will play out over the long term, and for every success story like Nvidia, there will be several failed companies left behind.

But here's the good news: You don't have to be a fortune teller to capture the upside AI has to offer.

Image source: Getty Images.

Exchange-traded funds offer a great risk-reward balance

An exchange-traded fund (ETF) is an investment fund managed by experts, who purchase dozens or even hundreds of individual stocks within a specific sector of the market or based on a specific theme. Then they package them into one single security (the ETF) for investors to buy.

It gives investors a convenient way to own a slice of a new industry like AI without having to pick individual stocks. An ETF is usually also protected from the failure of any one stock it owns because it's diversified and no single position is likely to dominate its portfolio.

Several AI-focused ETFs have hit the market over the last few years, but here are two great picks.

1. Ark Innovation ETF

The Ark Innovation ETF (ARKK 1.05%) is managed by Ark Investment Management, which is led by famed technology investor Cathie Wood. While ARKK isn't specifically an AI ETF, it has become a great proxy for the industry because the majority of the 34 stocks in its portfolio are using the technology in some capacity.

ARKK is heavily weighted toward its top five holdings, which account for 39.5% of the total value of its portfolio. Therefore, this ETF is prone to more volatility than most.

Data source: Ark Investment Management. Portfolio weightings are accurate as of Dec. 22, 2023, and subject to change.

Cathie Wood has long been one of the most bullish voices on Wall Street when it comes to Tesla, calling it the biggest AI play in the world. While it's the biggest electric vehicle company on the planet, it's also a leading developer of fully autonomous self-driving vehicle software. It relies on AI, and it could add an incredible amount of value to Tesla stock over the long term.

UiPath is another favorite for Wood. It develops software to help businesses automate their processes using AI. But ARKK also owns several other popular AI stocks outside of its top five holdings:

• Unity Software, which helps game developers create 3D experiences. It relies increasingly on generative AI tools to speed up the development process and craft new ideas.
• Palantir Technologies, which uses AI and machine learning to help organizations analyze high volumes of sensitive data at scale.
• Meta Platforms, which uses AI to feed relevant content to users on its Facebook and Instagram social media platforms.

The ARKK ETF delivered a powerful gain of 74% in 2023, which is almost triple the return of the S&P 500 index. However, as I mentioned, this ETF is prone to volatility and it's still down 66% from its all-time high.

ARKK is a great option for investors who want an easy way to buy a portfolio of AI stocks and who also have a moderate appetite for risk.

2. Global X Artificial Intelligence and Technology ETF

The Global X Artificial Intelligence and Technology ETF (AIQ 1.43%) is a more conservative option than ARKK. It holds 86 stocks so it's far more diversified, and its top five positions account for only 17% of its total portfolio:

Data source: Global X. Portfolio weightings are accurate as of Dec. 21, 2023, and subject to change.

That top five is packed with popular AI names. ServiceNow helps companies manage their IT infrastructure, and it offers a host of AI tools designed to automate and optimize processes. Amazon is quickly becoming an AI leader; it has developed its own large language models and its own data center chips, and it also invested $4 billion in generative AI start-up Anthropic a few months ago.

Outside of its top five, this ETF owns AI royalty like Nvidia, Microsoft, and Google parent Alphabet. It also has a position in Tesla, and one of my favorite up-and-coming AI companies, Oracle.

The AIQ ETF has delivered a gain of 54% in 2023 so, like ARKK, it's also crushing the S&P 500. But unlike ARKK, it's closing in on an all-time high! It's no surprise because AIQ owns each of the "Magnificent Seven" stocks, which have led the entire market higher this year.

AIQ is a great choice for investors who want to own all the best names in the AI industry while maintaining a conservative risk profile.