Aartificial intelligence: burst, bubble or collapse? Probably a mix of all three. Whatever happens, it increases investment risk. It suggests that many retirees and near-retirees need to review their portfolios.
The problem isn’t just that much of the stock market’s booming valuation depends on data centers, through companies like Amazon, Meta Platforms and Nvidia. It is that AI may prove so powerful that it destabilizes a large part of the economy. After that: unemployment, recession, market crash. Perhaps.
The alleged crash is far from certain. But the mere possibility should influence your thinking.
Now look at your retirement portfolio. If it’s in a target date fund, do nothing. The stock allocation is automatically reduced as you age.
If you’re young, you can stand doing nothing. If the market crashes, it will likely recover before you spend the money.
But if you’re over 55? And set the allocations yourself? You may have gone off course. That’s because stocks have risen far ahead of bonds.
If you had a traditional 60/40 portfolio a decade ago and didn’t make any adjustments or additions, now you have a one-sided 84/16 portfolio. More specifically: A 60% stake in the Vanguard Total Stock Market fund, combined with a 40% stake in the Vanguard Total Bond Market fund, would now be 84% invested in stocks and 16% in fixed income.
If either inertia or an uptrend has caused your portfolio to tilt, you have plenty of company. The Vanguard Group has the data, which comes from numbers in 401(k) accounts. Of latest researchfor December 2024, revealed that half of savers over 55 who manage their own allocations had more than 70% of their money in stocks. Given last year’s results (17% return in stocks, 7% in bonds), it’s possible that these people are in even riskier territory now.
Conflict; It has already come to software vendors. Adobe and Salesforce rent software to companies, software that could be degraded by artificial intelligence code-creating agents that compete with human developers. Their shares are down 40% or more in the past year. Block lays off 4,000 workers.
A wider crash is hypothesized by Citrini Research. In one vision of destruction Posted on February 22, two analysts there envision a world two years from now in which artificial intelligence has destroyed first coding jobs and then nearly every kind of white-collar job. People in insurance, travel bookings, finance, real estate, customer service or anything involving human intervention are getting the axe. Productivity is rising but so is unemployment. Laid-off product managers are taking jobs as DoorDash delivery people. Personal income tax revenues are collapsing. Mortgages remain unpaid. Financial chaos ensues.
It is a fantasy, ending, capriciously, with the modest disclaimer: “Some of these scenarios will not materialize.” However, this kind of talk makes you cringe.
Amazon, Meta, Alphabet, Microsoft and Oracle collectively plan to sink $700 billion into artificial intelligence this year. We can hope that this capital expenditure will not lead to a decline in living standards. There is precedent. Farm machinery cut jobs, but didn’t make the country poorer.
A less hysterical review of AI comes from Mark Zandi and fellow economists at Moody’s, the bond rating agency. In one recent report they optimistically assign a 40% chance to this positive outcome: AI causes some job losses, boosts productivity, keeps corporate profits up, and ultimately leads to prosperity.
Moody’s team puts a 25% chance (these rates are nothing more than hunches) of a pessimistic sequence: AI disappoints, its providers get far less revenue from it than they expected, their stock prices fall and undercut the tech-heavy S&P 500, spenders feel suddenly poorer cut back on spending and cut back on spending them.
Other outcomes, per Moody’s: 20% chance of a labor market upheaval leaving some skilled workers much better off and many workers worse off. 15% chance of incremental productivity growth of the kind seen in the early days of the Internet.
Even if you assign low odds to gloomy trajectories, it would be wise to rethink your portfolio allocation. The main reason for owning risky stocks is that, historically, they have done much better than bonds. But how well do past results predict future results?
It is known that, over the past century, US stocks have delivered a real return (return without inflation) of better than 7% per year. Less well known is what made this happen. Performance is driven by earnings yields (earnings divided by share price) averaging 7%.
The relationship is straight. Acme shares, trading at $100, gain $7. The $7 can come out as a dividend that can be used by the owner to invest in more stock, or used by Acme to buy other corporate assets with 7% earnings yields, or used by Acme to buy Acme’s stock. Through any of these three paths, Acme offers a 7% compounded annual return.
This is oversimplifying a bit. In the last century companies would have had to reinvest a portion of their profits to keep their profitability stable in real terms. This pushes the potential return below 7%. Offsetting this: Rising price/earnings ratios, pushing the stock’s historical return back above 7%.
An earnings yield of 7% equates to a P/E of 14. The S&P 500 is now trading at 28 times 2025 earnings, twice the historical norm. This tells you to expect future returns of only half the 7% seen in the past.
An expected return of 3.5% is better than what you get on Treasuries, but not better enough to justify the risk of having all your money in stocks. If you’re 84% in stocks and nearing retirement, you might want to reallocate some of the portfolio to Treasury Inflation-Protected Securities (TIPS).
Schwab has a TIPS exchange-traded fund with an annual fee of 0.03%. Vanguard and Fidelity have open-ended funds with annual 0.05%. All three funds have durations close to 7 years, with real returns averaging 1.5%. If your 401(k) provider won’t let you get cheap funds, ask your employer to fire the 401(k) provider.
If you’re investing in a self-directed IRA and have more than $100,000 to put into each position, buy equal amounts of TIPS due in 5, 10, 20 and 30 years. Average maturity: 16 years. Average real return: 1.9%.
