Artificial Intelligence: Boom, Bubble, or Bust?

So, what’s the deal with artificial intelligence? It’s likely a combination of all three: boom, bubble, and bust. And as exciting as that sounds, it also means that investment risks are on the rise. This increase urges many retirees or those close to retirement to reassess their financial strategies.

The challenge here is that a lot of the stock market’s hype is tied up in data-centric companies, think Amazon, Meta, and Nvidia. This situation suggests that AI’s impact could destabilize various sectors of the economy, potentially leading to unemployment, recession, or a market downturn. It’s a thought that gives pause.

Now, let’s consider your retirement investments. If you’re in a target date fund, you’re in a good spot—your stock allocation will naturally decrease as you age. But what if you’re older than 55 and managing your own allocations? It’s possible you might be off track, primarily because stocks are currently outperforming bonds by a substantial margin.

If you stuck with a traditional 60/40 portfolio a decade ago and made no changes, your allocation might now look closer to 84% in stocks and only 16% in bonds. This alteration comes largely from funds like Vanguard’s Total Stock Market Fund, skewing the balance much further towards equities.

Many investors, due to either complacency or excessive optimism, find themselves heavily invested in stocks. A recent Vanguard study revealed that about half of savers aged 55 and up who manage their own allocations have more than 70% of their portfolios in stocks. Given that stocks yielded a return of 17% last year while bonds offered just 7%, these older investors may now be exposed to greater risk.

As for the crash? Some signs are already noticeable—software companies like Adobe and Salesforce are feeling the pressure, with their stocks dropping significantly, and layoffs following. Analysts from Citrini Research paint a grimmer picture, stating in a recent report that AI could soon eliminate coding positions and drastically affect various white-collar jobs. Industries like finance and customer service could face significant job cuts. While productivity might improve, so might unemployment, leading to a chaotic economy.

It sounds a bit extreme, doesn’t it? Yet, such discussions leave me uneasy.

On the other hand, there’s substantial investment backing AI, with companies like Amazon, Meta, and Microsoft gearing up to spend around $700 billion this year. Hopefully, this doesn’t eventually translate into a drop in living standards, as history has shown that technological advancements can eliminate jobs without resulting in widespread poverty.

Contrastingly, Mark Zandi and his colleagues at Moody’s provide a more tempered perspective. In a report, they suggest there’s a 40% chance that AI will do more good than harm. This scenario could mean job transformations and increased productivity leading to overall prosperity.

However, they also estimate a 25% chance of a more bleak outcome where companies fall short of their AI revenue expectations, leading to stock price drops and potential recession. Then there’s a 20% chance of job market disruption leaving some skilled workers better off while others struggle.

Even if we assume the pessimistic scenarios aren’t likely, it’s prudent to reevaluate how your portfolio is allocated. Traditionally, stocks have outperformed bonds, but can we continue to rely on that historical pattern?

Over the last century, U.S. stocks have averaged returns of over 7% annually, influenced largely by their earnings yield. Generally, this yields higher returns through dividends and reinvestments. However, this might oversimplify things; some profits are often reinvested just to maintain earning power.

The market’s current P/E ratios suggest future returns may be halved, likely around 3.5%. While still better than many safe investments, it’s a reason to be cautious if you’re heavily invested in stocks, especially as retirement approaches. It might be wise to consider reallocating some of those funds into Treasury Inflation Protected Securities (TIPS).

Funds holding TIPS often come with low fees, making them an attractive option for risk-averse investors near retirement. For those in self-directed IRAs, securing some TIPS with staggered maturities could also offer a more balanced approach.