AI Could Be a Money Pit for Individual Investors
What’s the best way for an individual to invest in AI? That’s what some relatives asked me over the holidays.
The question is particularly relevant right now. Anthropic could go public this year, and OpenAI could follow, meaning individual investors could have access to two of the rare pure-play AI stocks.
That would be a big change from right now, when the only way to invest in some of the biggest names in AI is on private markets, largely the domain of institutions and wealthy individuals. Private fundraising is still racing ahead. On Tuesday, xAI said it raised $20 billion from a group of big investors and OpenAI is trying to raise $100 billion.
For now, individuals can only invest in companies like Microsoft and Google, where AI is an important part of their business, or data center companies such as CoreWeave, which are among the riskiest AI plays because of their high debt levels.
But even before the potential IPOs, opportunities for investors to put money directly into pure-play AI firms are appearing. Charles Schwab late last year bought Forge Global, a platform that lets individuals buy stakes in private companies. The idea, Schwab said, was to democratize access to private companies and give individuals the opportunities previously available only to the big guys.
You hear this kind of language a lot lately. Robinhood CEO Vlad Tenev said something similar when the firm announced its private markets fund last fall. “With Robinhood Ventures, everyday people will be able to invest in opportunities once reserved for the elite,” he said.
Schwab and Robinhood are offering this access because investors are asking for it and because the companies believe they can profit from it. Small investors, though, are unlikely to benefit.
Individuals have a terrible track record of chasing winners and buying at the wrong time. When they show up, it’s typically a sell signal, though there are always exceptions to the rule. Investors last year bid up shares of Oracle and CoreWeave, plus stocks stuffed with crypto, only to see them tumble.
AI offers multiple reasons for caution. In the stock market, millions of investors trade for different reasons. But the shareholders of the big private AI companies are almost all professionals who have been investing in these businesses for years. If they are selling, it is likely because they are sitting on enormous profits and want to take some money off the table.
They could be wrong, and the new buyers could be right, but if the companies were such great opportunities, individual investors would still be last in line to get shares. The only way they will move to the front is if they are willing to pay more than everybody else. Given the lack of information available to small investors, it would be easy for them to overpay.
Another reason for investors to be wary is that most AI companies need to raise billions in cash to pay for the chips they need to stay in the AI game. Companies such as OpenAI have already tapped most of the world’s biggest pools of capital—sovereign wealth funds, banks, private equity funds, the giant tech companies and big investors such as endowments. Individuals collectively represent one of the last untouched big pots of money, making them attractive to AI companies.
In truth, individuals already have lots of exposure to AI—they just may not know it. AI companies have tapped their pension funds and life insurance policies in the quest for cash. And because the tech companies betting on AI make up roughly a third of the S&P 500, most investors are already neck-deep in AI.
For more evidence on individuals’ lousy investing track records and their current exposure to AI, look at the exchange-traded funds that they typically use to bet on hot trends. These funds invest in narrow slices of the market, such as AI or cybersecurity. Nearly $7 billion poured into AI and big data funds in the first nine months of last year, far more than went into any other fund type, according to Morningstar, which tracks these statistics.
Not surprisingly, some of these ETFs are stuffed with the big publicly traded tech stocks that dominate the indexes. Others are bets on the real estate companies that build data centers, many of which depend on big tech companies for their growth.
Over the past three years, AI ETFs have performed well, largely because of their stakes in the giant tech companies. But the overall record of narrowly focused ETFs is dismal. Morningstar calculates that roughly 80% of the funds have underperformed global markets or closed in the past three years. Over five years, the number is 90%. The individuals who jumped in when the funds were hot likely suffered losses.
The most recent hot sector among these funds was the energy transition, which focused on renewable energy, electric vehicles and the like. Performance has tumbled and investors have fled. Even when funds have big gains, the average investor does poorly because they invest at the wrong time.
The problem is, investors typically chase recent performance, and history says the gains don’t last. “These tend to be volatile and quite trendy, so investors tend to invest at the worst time,” said Kenneth Lamont, a principal at Morningstar who has written extensively about AI and investing.
My answer to the holiday question was: Be careful. You already own this stuff whether you know it or not, and if you think you’re ahead of the game, you’re fooling yourself. I’m preparing for next year, when my relatives brag about the huge returns they made by ignoring my advice.
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