Are We in an AI Bubble? And What Should Investors Do About It?

Let's talk about bubbles. Are we in one right now, specifically with AI? The short answer is probably, to some extent. When people feel a technology is truly revolutionary, you're bound to see over-investment and over-build-out, which leads to those classic bubble-like symptoms. Eventually, a few big winners emerge, but there are a lot of losers along the way. AI will probably be no different.

So, what am I doing for my clients? Well, in some ways, nothing, and in others, quite a bit.

I don't know when the bubble will pop. I don't know the individual stock winners and losers. Anyone who claims they do is likely to be wrong the next time around.

Think about it: many of the people who successfully called the dot-com bubble or the Great Recession in 2008 have since called many crashes over the last 15-20 years that simply haven't happened. Following that advice has cost people quite a bit of money.

The Problem with Predicting the Future

A notable example, and this is no shade on the person, whom I consider very smart, involves a professional investment manager who made his name by correctly calling the dot-com bubble and navigating the 2008 crisis well. But then, he felt stocks got too expensive again in the 2010s. He's been calling for massive declines, north of 60%, to get back to historical norms and positioned his clients defensively. The result? Really poor returns for his clients.

Even if we get a big crash, I don't know that his clients will be better off than if they had just stayed invested the entire time. This is a testament to how incredibly hard it is to take your personal views on market valuation and turn them into successful long-term investing results. Our Strategy:

Control What We Can

For our clients at TWM, we aim to be prepared in advance for different market circumstances, and we are proactive, not reactive. We don't make big shifts based on headlines or new data. Instead, we focus on what we can control:

1. Your needs for money: Money you’ll need in the next few years, we invest outside of the stock market, and instead choose income producing investments like bonds.

2. The expected time frame: Money you are investing for the decades to come is invested towards growth, stocks are usually our choice. More time to handle the ups and downs.

3. Our tolerance for normal decline scenarios: We prepare for a 50% loss in stocks because it happens, and we shouldn't be surprised when it occurs. If you aren’t comfortable seeing your investments cut in half, then an all stock portfolio won’t be right for you, but we can help you find the right balance.

The Beauty of the Index

If you invest broadly, which I think makes sense for most people, you are inevitably going to own both the future winners and the losers of the AI race. The beautiful thing about broad-based investing, when you don't use leverage and have a long time horizon, is that your winners can more than make up for your losers.

• A Loss is Limited: If you own a $10 stock that goes to zero, you lost $10. That's your maximum loss.

• A Win is Unlimited: If that $10 stock turns into $100, you made $90.

This is the entire premise behind buying the entire index. Historically, a little over 3% of all stocks deliver all the excess returns above inflation. Most stocks kind of stink, and that will be true in the AI race as well. But when you buy all the stocks, you guarantee participation in those gigantic winners. Their gains overpower the losses, because you can win multiple times your initial money, but you can only lose your initial investment.

Investor vs. Gambler

If you try to pick the winners and avoid the losers, you might do extraordinarily well, or you might hurt yourself badly. Trying to time the market or pick individual stocks means you are taking chances with your money that you might not want to take.

I want to be an investor, not a gambler. The more we mess with our accounts—the more action we take—the more likely we are to make less than if we had just stuck with the plan. It's like going to the casino: the more you play, the more likely the house is to win. In investing, the less action you take, especially when you're broadly invested in an index, the more likely you are to do well.

Simple Strategy, Better Outcome

Some people will outperform the market, and some will call this AI bubble perfectly. But for most people, history shows that is largely attributed to luck. It's incredibly hard to predict the future successfully, time and time again.

So, what should you do? My two cents:

1. Be Prepared: Acknowledge that a bubble is probable, and there will be more in the future.

2. Buy All the Stocks: When things are going great and you wish you owned more Nvidia or Google, remember that you do own these stocks because they are part of your broad index.

3. Stay Diversified: When one of these stocks falls from grace, you won't have a huge portion of your money tied up in it.

The reality is, nine times out of ten, not trying to pick the winners and losers will leave you with more money in the end.

You need a portfolio that you can stick with—one that is prepared to weather all storms, good weather and bad. Be consistent, make course corrections if you drift, and trust the process. 

The information in this blog is the opinion of Nathan Tomkiewicz and does not reflect the views of any other person or entity unless specified. The information provided is believed to be  reliable and obtained from reliable sources, but no liability is accepted for inaccuracies. The information provided is for informational purposes and should not be construed as advice. Advisory services offered through Tomkiewicz Wealth Management, LLC, an investment adviser registered with the State of New York and Massachusetts.