It looks like artificial intelligence (AI) is more than the latest fad. The technology is becoming an integral part of how people do things, from work to play, offering solutions to simplify complex activities. Many companies are investing billions of dollars into it in their efforts to become leaders in aspects of the industry or to maintain their positions in their established arenas.
Based on various forecasts, AI could become a trillion-dollar industry, and the companies that succeed in leading the charge could create tremendous shareholder value. Naturally, many investors are trying to predict which ones are going to be the winners and allocate their funds accordingly. However, since it's important to diversify your portfolio across many industries, it doesn't make sense for most investors to pick too many AI stocks.
If you're looking for a way to get exposure to the AI revolution without placing too much money into that single industry, consider buying an exchange-traded fund (ETF) that's focused on AI. That would give you easy exposure to a variety of stocks in a single asset, allowing you to benefit from many winners without overexposing yourself to the space or increasing your risk through a lack of diversification.
There are many AI ETFs to choose from, but I would recommend buying the Vanguard Information Technology ETF (VGT -0.08%) and avoiding the Ark Invest Autonomous Tech and Robotics ETF (ARKQ 0.63%). Here's why.
The ease of indexing
Vanguard offers about 80 different ETFs that suit an array of different investing needs. What unites them is that they're all passively managed, meaning they each track an established index instead of having a fund manager choose the stocks. There are many benefits to this strategy.
First of all, it provides instant and wide diversification. The Vanguard Information Technology ETF tracks the MSCI US Investable Market Information Technology 25/50 Index, which includes 307 small-, medium-, and large-cap companies. It's a weighted index, so larger companies make up higher percentages of its total value. The top three components are Apple, Microsoft, and Nvidia, which collectively account for about 46% of the total.
Image source: Getty Images.
However, because there are so many stocks in the portfolio, the risk from any single company's potentially poor performance is minimized. And index funds don't have to pay highly compensated fund managers to choose stocks which stocks to buy and sell, their fees are much lower than those of actively managed funds. The Vanguard Information Technology ETF has an expense ratio of just 0.09%, which compares quite favorably with the industry average of 0.92%.
Because AI and technology have been huge growth industries, this ETF has delivered fantastic results over the medium term. In fact, it has been Vanguard's best-performing ETF over the past 10 years, with 19.8% annualized gains. AI is still in its infancy, and as the market looks like it's recovering, now could be a great time to take a position.
Risk with low diversification
The Ark Invest Autonomous Tech and Robotics ETF has also done well over the past 10 years, but not nearly as well as the Vanguard ETF.
ARKQ Total Return Level data by YCharts.
It experiences many of the same tailwinds -- and risks -- as the Vanguard fund does in terms of industry growth, but the Ark fund is a riskier investment because it only has 37 components. So when some of them go south, its portfolio will take a proportionally more intense beating. Moreover, in broad market downturns, many traders tend to run to safe stocks. In such times, those value stocks can cushion a portfolio. An ETF that's focused solely on growth stocks is bound to feel more pain in those times, though its relative portfolio diversity will mitigate some of that risk.
The Ark Invest Autonomous Tech and Robotics ETF also focuses more on emerging stocks than market leaders. Its top holdings are -- in sharp contrast to the Vanguard ETF's established giants -- Tesla, Kratos Defense and Security, and Palantir Technologies. These stocks trade at ambitious valuations, which makes them more susceptible to steep drops if the market's mood changes or their business results come under pressure.
Both of these ETFs are riskier than a value-oriented ETF or even an ETF that tracks a broad index like the S&P 500. But over time, they have so far rewarded investors who can handle that risk. If you're ready to invest in the future of AI but are concerned about current market uncertainty, the Vanguard Information Technology ETF looks like a smart way to play it.
