Why Investing in Index Funds is the Best Way to Invest in AI

AI is everywhere.

Breaking news, right?

Even though AI has been around for a few years (ChatGPT came out in November 2022), it feels like you can’t avoid it today.

Just about every major company out there is either selling an AI product or is using AI as a core piece of its customer experience.

My law firm gets pitched just about every week on a new AI product, whether it’s to help with legal research, search documents, or organize case files.

As a customer, I’ve had way too many AI chatbot conversations recently.

One day I’m talking to a Hertz chatbot because I was overcharged for gas. The next day I’m talking to a SiriusXM chat pot to cancel my subscription. Then, United funneled me to a chatbot to switch my seat on a flight.

Unfortunately, in each of the above examples, the chatbot could not solve my issue. After too much time wasted talking to the robots, I was transferred to a real life human where my issues were resolved promptly.

By the way, is it accurate to say I “talked” to an AI robot? Can we really talk to things that aren’t alive? Like, if I was talking to my couch right now, you’d be worried about me, right?

The point is, AI is here to stay. As time goes on, AI will make life easier for all of us, whether that’s at home or at work.

And, that leads us to the question of the day.

Am I personally investing in AI?

A buddy asked me at work the other day if I’m investing in AI. It’s a pertinent question, considering what we just discussed.

AI is everywhere.

So, what can you do if, as an investor, you want a piece of the action?

1. Do you need to predict the winners and the losers in the AI arms race?
2. Should you place outsized bets on the companies that have a head start today?
3. Maybe you follow the hot stock tip you heard at the Halloween party last weekend?

Nope… nah.. and please don’t.

There’s a much easier solution to make sure you get a piece of the AI action.

It’s what I’m personally doing.

Buy index funds.

When you invest in index funds, you are investing in AI.

The reality is that if you are an index fund investor like me, you are heavily invested in AI.

Take a look at the extremely popular total stock market fund from Vanguard, VTSAX.

Here’s how Vanguard describes VTSAX:

Created in 1992, Vanguard Total Stock Market Index Fund is designed to provide investors with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks. 

So, when you own VTSAX, you own a piece of the entire US stock market.

But, what does that actually mean? What do you really own when you own VTSAX?

For starters, you own a lot of technology companies pouring a ton of money and resources in AI.

Technology stocks make up 38% of VTSAX, by far the most of any sector.

The next biggest sector is Consumer Discretionary at just over 14%.

Guess what kind of companies fall into the Consumer Discretionary sector?

Amazon, for one.

Tesla, for another.

Combined, Technology companies and Consumer Discretionary companies make up more than half of all VTSAX.

To take it a step further, can you guess the largest individual holdings in VTSAX?

In order, from the largest holding on down:

• NVIDIA
• Microsoft
• Apple
• Amazon
• Facebook
• Broadcom (semiconductors)
• Alphabet (Google)
• Tesla

Does anyone doubt that these companies are heavily involved and invested in the latest technological advancements, especially AI?

You don’t need to be a stock picker or a market analyst to reach that conclusion. You just need to be a regular consumer. You’ve surely had experiences like I’ve had with the chatbots.

So, if you own VTSAX, you can truthfully say that you are heavily invested in AI.

Why you should own index funds if you want a piece of the AI action.

For my money, there’s no beating index funds.

More important than my money, for my sanity, there’s no beating index funds.

This is more relevant than ever with the emergence of technologies, that frankly, I can’t begin to comprehend how they work.

The good news is that with index funds, I don’t have to know what a semiconductor is or how quantum computing works.

I can just sit back and trust that at least some of the biggest companies in the world- with the most resources and the smartest people- are going to figure it out.

When they do, I will own a piece of the action because I own index funds.

Along the way, I don’t need to ride the ups and downs and bet my family’s future on one company or another. I can own them all.

If you’ve been a consistent reader of the blog, you know that money is as much emotional as it is rational.

I don’t want to be worried about my money any more than you do. I certainly don’t want to worry about which AI companies are going to win or lose.

That’s why the reasons I love index funds take into account both the numbers and the emotions of investing.

7 things I love about index funds.

1. Anybody can do it
2. No wasted mental energy
3. Low fees
4. Automatic diversification
5. The closest thing to predictability
6. I don’t have stock FOMO
7. Good enough for Buffett, good enough for me

1. Anybody can do it

I’ve said it before, and I’ll say it again:

Investing is actually the easy part.

And, when I say investing is actually the easy part, I’m talking mostly about investing in index funds.

You don’t need an MBA or a financial background. You don’t need to read the Wall Street Journal. Of course, you don’t need to guess which AI company is going to be the best.

All you need to do is consistently fuel your investment account and to let compound interest work its magic.

Oh wait, one more thing:

You also need to read Think and Talk Money. I post three times every week. 

Oh, and tell your friends about Think and Talk Money!

2. No wasted mental energy

It goes without saying that most professionals are busy people. On top of working our day jobs, we’re also doing our best to stay healthy, be good family members, and have some semblance of a social life.

Some of us even have side hustles that occupy our time and mental energy.

The last thing we need is another stressor in our lives, like actively trading stocks and studying the premier AI companies.

I invest in index funds to take this stressor out of my life.

Yes, I could pay someone a lot of money to manage my money for me.

Or, I could invest in index funds and rest comfortably knowing that I’m going to be in great financial shape down the road when AI becomes even more prevalent.

3. Low fees

Because index fund are passively managed, the fees are significantly lower than actively managed mutual funds.

My favorite index fund is Vanguard’s previously mentioned Total Stock Market Index Fund (VTSAX). This fund currently charges .04%, which is just about the lowest fee you will ever see.

Compare that to the 1% fee commonly charged by investment advisors. Also, don’t forget it’s very difficult for even the professionals to beat the returns consistently generated by the S&P 500. 

If you don’t think that difference in fees matters, check out my post on what a 1% fee really costs you:

How Much Money a 1% Advisor Fee Really Costs

While I can’t control what AI companies are going to succeed, I can control the fees I pay while I’m along for the ride.

I’d rather pay .04% than 1%. 

That’s especially true when there’s no guarantee that an advisor can perform better than the returns I earn through index funds. 

4. Automatic diversification

By investing in an index fund, like an S&P 500 index fund or a total stock market index fund, my stock portfolio is by definition diversified.

For example, when I invest in an S&P 500 index fund, I essentially own a piece of 500 large companies.

Some companies may go up in value, others may go down. I’ll never know which ones are going to make money or lose money.

By investing in an S&P 500 index fund, it doesn’t matter. I’m covered either way.

When it comes to an emerging technology with lots of companies vying for domination, it’s particularly important to not put all your eggs in one basket.

That’s the point of diversification: smooth out the ride so I’m less susceptible to the fortunes of one particular company.

VTSAX offers exposure to nearly the entire U.S. stock market, which consists of 3,598 companies.

Some of these companies are going to figure out AI. Others, are going to fail. I’m good either way.

Now, that’s really good diversification.

5. The closest thing to predictability

The S&P 500 has historically earned an average annual return of 10%.

By investing in an index fund that tracks the S&P 500, like I do in my 401(k), I have a pretty good chance of earning consistent returns in the long run. 

Sure, there may be ups and downs. 

But, check this out:

Since 1996, the S&P 500 has ended the year in positive territory 23 times and negative territory only 7 times. 

In other words, the S&P 500 has generated positive returns three times more frequently than it generates negative returns.

And even with those 7 negative years, with the exception of 2000-2002, the S&P 500 returned to positive territory the following year.

What this all means is that while the S&P 500 will drop occasionally, the down periods are historically short-lived.

Because of this historical consistency, index funds give me the best shot at predictability.

Predictability seems more important than ever with the emergence of AI and the unknown effects AI will have on the global economy.

Note that predictable returns does not mean guaranteed returns. There are no guarantees in the stock market. That’s why my preference is predictability.

I’m very happy with consistent returns and a smoother ride.

6. I don’t have stock FOMO

Depending on the index fund you choose, you may own pieces of a handful of companies or as many as 3,598 companies.

I invest in S&P 500 index funds and total stock market funds. That means I own pieces of lots of companies. 

It also means I never have stock FOMO.

You know what stock FOMO is, right? 

Stock FOMO is when you find yourself in a conversation talking about something fun like your favorite new show. Then out of nowhere, someone volunteers the hot stock he bought that’s up 20%.

If you have stock FOMO, you feel like you’re missing out by not owning that stock. You think to yourself, “Oh man, that guy’s going to be so rich and I missed the boat!”

You might even run back to your desk so you can buy that hot stock, not realizing that you’ve probably already missed the train.

Stock FOMO can cause a lot of stress. These days, everyone seems to have an hot AI stock tip.

I don’t want that stress.

So, I invest in index funds. 

When a stock jumps 20%, I feel good because I already own every company in the U.S. stock market.

No AI stock FOMO here.

7. Good enough for Buffett, good enough for me

In 2013, Buffett famously instructed that after he dies, his wife’s cash should be split 10% in short-term government bonds and “90% in a very low-cost S&P 500 index fund.”

Good enough for Buffett, good enough for me.

It’s not just Buffett, though. One of my favorite authors on investing, J.L. Collins, wrote about the advantages of investing in a total stock market index fund in his seminal book, The Simple Path to Wealth. 

In fact, Collins makes a compelling argument that the Vanguard Total Stock Market Index Fund (VTSAX) we discussed above may be the only stock fund that you’ll ever need.

Buffett and Collins are smart guys. Taking advice from smart guys seems like a good idea to me.

I highly encourage you read The Simple Path to Wealth.

You can read my full review of The Simple Path to Wealth in my post here.

What do you think of investing in index funds so you own a piece of every AI company?

To recap, I own index funds so I can own a piece of every AI company. Doing so provides me numerous benefits, like:

1. Anybody can do it
2. No wasted mental energy
3. Low fees
4. Automatic diversification
5. The closest thing to predictability
6. I don’t have stock FOMO
7. Good enough for Buffett, good enough for me

My reasoning combines the emotional side and the rational side of investing. 

Like you, I want to earn a nice investment return. At the same time, I don’t want to be worried about my investments 24-7.

I certainly don’t intend on studying the financials of every technology company to try to guess who is going to win the AI race.

Index funds give me the best of both worlds.

Do you agree? If you are investing in individual AI companies, how did you choose which ones to bet on?

Let us know in the comments below.