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The Bank of England has expressed concern about the valuations of the big technology firms, warning that that a ballooning AI bubble could burst and result in a ‘sharp correction’ in the stock market.
Read on to find out what’s happening and what impact a possible correction could have on your pension.
What’s on this page?
Whether you love it or hate it, artificial intelligence (AI) is revolutionising the way we live and work. Even if you don’t personally use ChatGPT or Gemini to write emails or plan your holiday, you’ll still be engaging with AI some way when you shop online, use social media or contact businesses. If you’ve been unwell recently, AI might have been involved then too, with half of hospitals now using it as part of the diagnostic process.
This has resulted in huge growth in the companies involved, as James Scott-Hopkins, founder of wealth manager EXE Capital Management, explains: “Nvidia has recently become the first company in the world to reach a market value of $5trn (£3.8trn). Its value now dwarfs all 350 constituents of the FTSE 100 and FTSE 250 indices, whose combined market value is about $3.4trn (£2.6trn).
“The companies that make up the so-called Magnificent Seven [Nvidia, Microsoft, Meta, Apple, Amazon, Alphabet and Tesla – all of which are tech-based and investing significantly in AI] now account for more than a third of the US S&P 500 Index.”
Jason Hollands, managing director at Best Invest, adds: “Fervour about the potential of AI has seen vast amounts of money flow into companies involved with AI, including those developing the advanced computer microchips and other hardware needed to power it, those involved with building and housing massive data centres and providing the required cooling systems.
“This has stoked concerns of an investment bubble, as we saw from 1995-2000 when the internet took off and the ‘dotcom’ bubble ballooned and then spectacularly burst.”
But while the leaders in AI are largely US-based, the UK wouldn’t be immune if their share prices suffered a fall. “The Bank of England has flagged concern that if the AI mania comes to an abrupt end at some point, it will have a contagion-like effect on other markets too, including on pension funds,” he adds.
This is the billion-dollar question.
Laith Khalaf, head of investment analysis at AJ Bell says that there are definite similarities between the current environment and the ‘dotcom boom’. Once again, we’re worrying about tech firms’ share prices. But, he points out, this time there is a significant difference.
“Even if AI disappoints and the big technology companies which sit at the top table of the US stock market don’t make the profits that are currently baked into prices, these companies do have highly profitable businesses which could act as a safety net on any price falls. Some of the biggest failures from the ‘dotcom boom’ weren’t mature companies with hundreds of millions of customers, some were simply ideas wrapped in a corporate shell, which was then floated on the stock market.”
The worry, says Hollands, is that revenues from AI might not be proportional to the investment it demands. “AI is going to have a voracious appetite for ongoing capital investment – ever more powerful computer chips that needed to be upgraded and vast amounts of energy to power supercomputers and cooling systems to stop them overheating.
“Actual revenues for AI platforms like OpenAI [the owner of ChatGPT] are currently tiny in proportion to the volume of investment going in: could the tech giants be burning cash in the pursuit of profits that may never emerge?”
But Scott-Hopkins points out that while a correction is possible, prices could still continue to rise for a few years more. “If truth be told, no one can accurately predict what lies ahead, and so it’s important not to panic or make knee-jerk reactions.
“The biggest mistake people can make is to sell shares during a market decline to try to stop making losses, because, in my experience, no one ever gets back in the market on time, as they are convinced the market will go to zero and lose everything.”
These concerns put pension holders (and other investors) in a difficult position. You don’t want to miss out on future growth, but nor do you want to risk the savings you’ve worked hard to build.
Generally when stock markets fall, the message is to ‘keep calm and carry on’. By remaining invested you get the opportunity ride out volatility and recoup your losses, which would have been crystallised if you had cashed them in. But that’s easier said than done when you’re approaching retirement, or you have already retired and living off an invested pension.
The good news is that if you’re in the run-up to retirement, your pension may already have safeguards in place to protect your savings from short-term volatility.
Adam Vanstone, chartered financial planner at Chester Rose Financial Planning, explains: “The default fund that workplace pensions often use provides a reasonable level of diversification across different stocks, but importantly also across various asset classes. Although not guaranteed, this can provide some downside protection during periods of market volatility.”
He adds: “Workplace pensions also offer a ‘lifestyle option’, in which exposure to riskier assets, such as equities, reduces automatically as you approach your retirement age. So it may be that you are already in a pension that includes lifestyling, which offers more protection from a stock market crash, although this varies by provider and should be checked.”
If you have chosen your pension investments yourself (for example with a personal pension or SIPP), you might need to review your current position more closely.
Hollands says: “I would suggest people check how exposed their pension or investments are to US equities (shares), whether that is through owning US funds, or global funds. US shares now represent 74% of global equity markets, so a ‘global’ fund may not be as globally diversified as you think.”
“If you find you have very high US exposure, and to the tech giants in particular, consider diversifying more broadly, both to other types of investment such as bonds, infrastructure, absolute return funds and gold, but also spread your equity exposure to include other regions such as the UK, Europe, Japan and emerging markets which are far less directly exposed to the AI theme.”
However, he stresses that it’s important not to ditch the US altogether. “The US is the largest economy in the world and home to many world class businesses – just don’t have too many eggs in one basket.”
The same guidance also applies if you are investing in a stocks and shares ISA.
Vanstone adds that you don’t just need to think about where you’re invested, but about your own circumstances as well.
“The action to take to protect yourself from a stock market correction depends on several factors. These include your investment timeframe, how reliant you are on the pension fund to meet your income needs in retirement, whether you want a guaranteed income for life when you retire by buying an annuity, or plan to draw on your pension pot as you go.
“How comfortable you are with investment risk and your ability to withstand a fall in value of your pension funds are also important to consider.”
He adds: “If you intend to purchase an annuity, reducing investment risk in the years leading up to it may be an appropriate approach. However, if you are looking at the drawdown option, a better approach may be to de-risk the proportion of your pension pot that you will need in the first few years, although the right approach will depend on your overall retirement plan.”
If you used your pension to buy an annuity, that income won’t be affected by stock market movements. But if you’re using income drawdown, you may want to review your investment strategy, as your pension will still be invested in the stock market.
Depending on your age and attitude to risk, this will be about striking the right balance between safeguarding your pot but maintaining some potential for further growth – especially if you’re still in the early years of retirement. And, if stock markets do fall, it may make sense to use cash savings instead and reduce the pressure on your pot.
Ian Futcher, financial planner at Quilter, says: “For those already drawing from their pension, managing volatility will be even more crucial to ensure your money lasts the full duration of your retirement. Regularly assessing where your money is invested, as well as reviewing your withdrawal rates can help ensure you are drawing money sustainably as market conditions change.
“Outside of your pension, it is a good idea to continue investing tax efficiently at an appropriate risk level for you, such as in a stocks and shares ISA, to help build your overall long-term retirement pot.”
Whatever stage you’re at in your retirement journey, stock market volatility can be a major cause of concern. Quitting the stock market might help you sleep all night but you could end up worse off in the long run, so for most people it’s a case of trying to strike the right balance.
If you’re concerned or not sure what to do, it’s a good idea to discuss your situation with a financial planner, or explore sources of free guidance. Futcher adds: “The right level of risk and diversification will differ from person to person, so seeking professional financial support wherever possible will be vital, be that through a financial adviser or government-backed services such as MoneyHelper.”
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