The S&P 500 Is Dominated by AI. If the Bubble Pops, History Says These 2 ETFs Could Be the Smartest Buys. |

The artificial intelligence (AI) trade has taken over the stock market. It’s not just major tech players and semiconductor stocks. A wide range of U.S economic sectors, like industrial stocks, are now growing because of the AI boom.

According to recent research from Bloomberg, AI-related stocks are now responsible for about 53% of the S&P 500 index by weight. If AI technology can lead to widespread productivity gains throughout the economy, this AI-centric stock market doesn’t have to be a problem. But in case of a downturn in the S&P 500, this top-heavy weighting toward AI-related stocks might mean that there won’t be many safe places for investors to hide.

Is there any alternative to investing in AI within the S&P 500, or to diversify your investments away from a possible tech bear market? Based on Bloomberg’s research, buying more energy stocks and U.S. Treasury bonds might be good choices to reduce volatility without missing out on most of the S&P 500 index’s returns.

Let’s look at two exchange-traded funds (ETFs) that could fit this strategy of buying more energy stocks and bonds to (hopefully) reduce the risk of an AI downturn.

Vanguard Energy ETF (VDE): 111 stocks, five years of 21.1% annualized returns

Bloomberg’s research found that, based on the past 12 months of performance, reducing an S&P 500 tracker portfolio’s tech exposure by 10% and increasing exposure to energy stocks would have reduced the portfolio’s volatility by 1.7% while only reducing one-year returns by 1.4% compared to the S&P 500. That’s a significant reduction in volatility while still capturing most of the S&P 500’s annual return.

Bloomberg didn’t recommend any specific stocks or ETFs, but one fund that could fit this strategy is the Vanguard Energy ETF (VDE +1.27%). This fund lets you own 111 stocks and has delivered average annual returns of 8.19% for the past 21 years since the fund’s inception in September 2004. It has outperformed the S&P 500 for the past five years, with annualized returns of 21.1% during that time.

The Vanguard Energy ETF invests in energy companies such as oil and gas companies. Its top three holdings are ExxonMobil (21.98% of the fund), Chevron(14.2%), and ConocoPhillips(5.8%). It charges a low expense ratio of 0.09% and ranks among the best energy ETFs.

There’s no such thing as a “safe” stock or sector of stocks. But based on past performance, energy stocks sometimes deliver steadier returns when the rest of the market is going through a downturn. Buying the Vanguard Energy ETF is an easy, low-cost way to buy into the energy sector, and could be a good defensive move to diversify away from the AI trade.

Vanguard Total Bond Market ETF (BND): Three years of 3.95% annualized returns

Bonds don’t often beat stocks for the long run, but they can provide stability during times of stock market downturns. Bloomberg’s research found that, compared to the S&P 500 index’s performance in the past 12 months, boosting exposure to U.S. Treasury bonds by 10% would have reduced the portfolio’s volatility by 1.7%, while delivering 5.6% lower returns than the S&P 500.

Buying bonds is an important part of most people’s investment portfolios, especially for people closer to retirement age. One easy way to buy bonds at a low cost is to invest in the Vanguard Total Bond Market ETF (BND 0.27%). This bond ETF offers a diversified portfolio of 11,455 bonds, including U.S. Treasuries, with an ultra-low expense ratio of 0.03%. It’s on the list of best bond ETFs.

During the past three years, this bond ETF has delivered average annual returns (by net asset value) of 3.95%. Over the long term, since the fund’s inception in April 2007, the Vanguard Total Bond Market ETF has delivered annualized returns of 3.08%.

There’s no guarantee that any investment is safe in case of a stock market downturn. Energy stocks could decline if oil prices go down because of the Iran war ending. Bonds don’t always move in the opposite direction from stocks. But if you’re worried about overvalued AI stocks or a top-heavy S&P 500 index, these two Vanguard ETFs could be worth a look.