As the development of artificial intelligence (AI) systems continues to advance at a torrid pace, this emerging technology is poised to disrupt the global economy and transform entire industries. It's a revolution sure to create winners and losers -- companies that fail to adapt will be left behind.
As such, broad-based index funds like the Vanguard Total Stock Market Index Fund ETF (VTI -0.00%) may not be the best choices for investors today.
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AI's disruptive potential and economic impact
AI has the potential to disrupt virtually every economic sector, industry, and sub-industry, from healthcare and finance to manufacturing and transportation. As AI-powered software systems and robotics become part of everyday life, they will fundamentally change the way businesses operate. Those companies that most successfully leverage AI to improve efficiency, reduce costs, and create new products and services will likely gain significant competitive advantages.
However, this disruptive potential also poses significant risks for companies that are ill-suited for this next phase of technological evolution. Companies in legacy industries such as retail, many forms of insurance, and fossil fuels, for example, may struggle to keep pace with the rapid changes brought about by AI. Many may find themselves rendered obsolete, leading to job losses and economic disruption.
Rethinking diversification: The limitations of broad-based index funds in the age of AI
In light of AI's transformative potential, investors may need to reconsider their allocations to broad-based index funds like the Vanguard Total Stock Market Index Fund ETF. While this popular fund provides exposure to more than 3,700 U.S. companies across all economic sectors, it may not be the optimal choice for the age of AI.
On one hand, the Vanguard Total Stock Market Index Fund ETF is heavily tilted toward information technology stocks: Because it is weighted by market cap, eight of its 10 largest holdings are core AI stocks like Microsoft, Nvidia, Apple (AAPL 2.00%), Amazon (AMZN 3.90%), and Alphabet.
However, approximately 71% of its remaining holdings are spread across various sectors, some of which may face significant challenges in adapting to this new technological landscape.
Given that technology will dominate most aspects of our daily lives and potentially rebalance the world order, investors may need to rethink the benefits of the broad diversification inherent in funds like the Vanguard Total Stock Market Index Fund ETF.
Why? Despite numerous tech executives and experts in the space publicly warning the world about the impending changes over the next two to three years, a sense of disbelief still persists among the general population.
This sentiment is likely to shift this fall with the rollout of OpenAI's next iteration of ChatGPT, the introduction of Apple Intelligence, and the launch of Amazon's Alexa Plus. Apple Intelligence, in fact, is likely to be an eye-opening moment for a large fraction of the populace thanks to the popularity of the company's iconic iPhone. And the emergence of relatively affordable advanced robotic systems soon thereafter will only add fuel to the fire.
As the AI revolution unfolds, investors may want to adopt a more targeted approach to portfolio construction, focusing on companies and sectors that are built to thrive in this new era. While broad-based index funds have served investors well in the past, the age of AI may justify heavier concentrations in tech and tech-adjacent fields.
Capitalizing on the AI revolution with tech-oriented ETFs
Tech-oriented exchange-traded funds (ETFs) like the Invesco QQQ Trust (QQQ 0.21%), the Vanguard Growth ETF (VUG 0.43%), or the Vanguard Information Technology ETF (VGT 0.20%) would be ideal ways to play this trend.
The Invesco QQQ, which tracks the Nasdaq-100 index, offers exposure to many of the leading technology companies at the forefront of AI.
The Vanguard Growth ETF focuses on large-cap U.S. growth stocks and its portfolio includes many of those same companies. However, it sports a broader mix of assets than the Invesco QQQ.
For investors seeking a highly concentrated tech fund, the Vanguard Information Technology ETF may be an attractive option. As of this writing, Microsoft, Apple, and Nvidia make up approximately 46% of its portfolio.
As the age of AI unfolds, investors may want to consider reducing their broad market exposure and increasing their allocations to these and similar tech-oriented ETFs. These funds' heavier tilts toward the businesses best positioned to benefit from AI make them attractive growth and hedging vehicles for the coming era of ultra-smart machines.
