Investing in Artificial Intelligence (AI) Stocks Can Be Risky; Here's a Terrific Way to Do It

Artificial intelligence (AI) was the dominant theme in the stock market last year, and a growing number of businesses are using the technology.

According to Goldman Sachs, 36% of companies in the S&P 500 index mentioned AI in their conference calls with investors during the fourth quarter of 2023, which was up from 31% just three months prior. Investors' interest is beyond piqued, but it will be increasingly difficult to pick winners and losers in the AI race amid the expanding playing field.

Shares of Nvidia, for example, have soared more than 40% in 2024 already, after jumping nearly 240% in 2023. Shares of Upstart Holdings, on the other hand, have plunged 32% so far this year after a 210% jump last year. AI is central to both companies, but their businesses are very different, and AI alone isn't always enough to buoy investors' enthusiasm.

But investors don't need a crystal ball to profit from the AI revolution. Here's how they can own a portfolio of AI stocks while limiting exposure to the inevitable failures.

Image source: Getty Images.

Exchange-traded funds can offer the perfect balance of risk and reward

Rather than purchasing several individual AI stocks (which involves picking winners and losers) investors can buy an exchange-traded fund (ETF) focused on AI. An ETF can hold hundreds of individual stocks, and it's managed by professionals who make adjustments to the portfolio as necessary.

Therefore, investors can benefit from the upside offered by the AI industry while protecting themselves from companies that might fail -- and if past technology booms have taught us anything, there will be many failures.

A number of AI ETFs have come to market in the last few years, but here's why the iShares Robotics and Artificial Intelligence Multisector ETF (IRBO 1.98%) and Global X Robotics & Artificial Intelligence ETF (BOTZ 2.52%) are two great picks.

1. iShares Robotics and Artificial Intelligence Multisector ETF (IRBO)

The goal of the IRBO ETF is to give investors exposure to companies at the forefront of the AI and robotics industries. It holds 111 stocks and securities from all over the world, so it's one of the most diversified options available.

IRBO is also quite evenly distributed compared to other AI ETFs, because its top 10 holdings account for just 13% of the total value of its portfolio -- and that top 10 includes some of the best AI names investors want to own:

Data source: iShares. Portfolio weightings accurate as of Feb. 15, 2024, and are subject to change.

Semiconductor design company Arm Holdings is IRBO's top position. Its stock has soared 60% in 2024 already, which is why it has amassed the largest weighting in the ETF by a wide margin. IRBO also owns the two main semiconductor heavyweights in the AI space: Nvidia and Advanced Micro Devices.

IRBO also owns a stake in a number of companies that are using AI to enhance their core businesses. For example, Meta Platforms uses AI to deliver more relevant content recommendations to users on Facebook and Instagram. Music streaming platform Spotify uses it for a similar purpose.

The IRBO ETF has delivered an annual return of 8% since inception (2018), which underperforms the 10.2% average annual return of the S&P 500 going back to 1957. However, IRBO's one-year return is 36%, compared to 22% for the S&P 500.

I normally wouldn't focus too much on a single year, but it happens to be the time frame in which AI has really gathered momentum. If stocks like Arm, Nvidia, AMD, and Meta Platforms continue to soar, it will help drive IRBO to market-beating returns.

2. Global X Robotics & Artificial Intelligence ETF (BOTZ)

While the BOTZ ETF is similar to IRBO in name and objective, its makeup is very different. It holds just 42 stocks and securities, so it's far more concentrated.

In fact, its top 10 holdings account for a whopping 70.6% of the total value of its portfolio. Its top holding -- Nvidia -- makes up almost 20%:

Data source: Global X. Portfolio weightings accurate as of Feb. 16, 2024, and are subject to change.

More than half of the stocks in the BOTZ top 10 are listed outside the U.S. For example, ABB Ltd is a Swiss engineering giant that develops hardware and software solutions for electrification and automation. Similarly, Japanese companies Keyence Corporation and Fanuc Corp develop products and equipment required to automate factories and manufacturing processes.

BOTZ also holds U.S.-based powerhouses like Intuitive Surgical, which makes robotics products to improve clinical outcomes in the healthcare industry. Then there is UiPath, which develops automation software -- this stock has become a favorite for tech investor Cathie Wood.

ETFs that are heavily weighted toward their top holdings can be a double-edged sword for investors. BOTZ has generated a 9.85% average annual return since inception (2016), which is better than IRBO. It has also crushed both IRBO and the S&P 500 over the past year with a 38.6% return.

However, if Nvidia stock suffers a steep decline, it could have an outsize negative impact on those returns because the company makes up such a large portion of the ETF.

For that reason, BOTZ might be a good choice for investors with a more aggressive risk profile, whereas IRBO could be the right pick for those who are more conservative.