The Free-Lunch Strategy to Reduce Risk From Tech Stocks

Notepaper with "Free Lunch This Way" written on it pinned to a corkboard

(Image credit: Getty Images)

As it turns out, DeepSeek, the new Chinese artificial intelligence (AI) app, did not deep-six the stock market – at least not for long. But it may have reshaped the perception of what the rollout of AI will look like in coming years, and it might have you thinking you need to reshape your portfolio, too.

The late-January rout caused by DeepSeek's arrival in the U.S. was ferocious, if short-lived. News of the cheaper, open-source AI model sent chipmaker Nvidia (NVDA) spiraling to a 17% loss that shaved nearly $600 billion in market value – a one-day record.

Utilities powering the AI boom, including Vistra (VST) and Constellation Energy (CEG), also tanked. AI-related stocks remained volatile, even as some experts noted that, although AI beneficiaries (and their stock market leadership) may evolve over time, the technology will remain a dominant force in the economy and financial markets.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just ~~$107.88~~ $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

https://cdn.mos.cms.futurecdn.net/flexiimages/y99mlvgqmn1763972420.png

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

"We think cheaper AI means more AI, more quickly," said economists at the bank BNP Paribas, in a note to clients. "This should mean a greater and more rapid productivity boom as the AI rollout snowballs."

As those productivity gains filter through corporate America, expect the fortunes of S&P 500 companies beyond the tech behemoths known as the Magnificent Seven to prosper, says Ed Yardeni of Yardeni Research.

Capitalize on broadening market gains with an equal-weight fund such as the Invesco S&P 500 Equal Weight (RSP).

The free-lunch portfolio strategy

You are not alone if, in the wake of January's upheaval, you are contemplating whether to trim your tech-stock holdings and shift into more defensive sectors.

One way to do that is with a strategy that CFRA Chief Investment Strategist Sam Stovall calls the "free-lunch portfolio."

The strategy calls for a portfolio (or a portion thereof) to be split 50-50 between tech stocks and shares in consumer staples companies. The latter are models of stability, says Stovall, because consumers buy staples such as groceries no matter what.

"When the going gets tough, the tough go eating, smoking and drinking," he quips.

The free-lunch part comes in when you combine the two sectors. In theory, you'll get most of the return delivered by a pure tech-stock portfolio while taking less risk to get it.

Behind Stovall's reasoning: From the start of 1990 through late December 2024, stocks in the information technology sector of the S&P 500 delivered an annualized return of 14.2%, compared with 10.7% for the S&P 500.

The standard deviation (a measure of volatility, or risk) for the tech sector was a whopping 30.8%, compared with 17.6% for the S&P 500 – showing the tech sector to be 75% more volatile than the market as a whole.

Combining the S&P 500 tech and consumer staples sectors delivered a 13.3% annualized return over the period, with a standard deviation of 18.6%. A hypothetical free-lunch portfolio (rebalanced annually) therefore captured 94% of tech's return with only 60% of the volatility. Bon appétit!

Investors can whip up a free-lunch portfolio with exchange-traded funds such as the Consumer Staples Select Sector SPDR Fund (XLP) and the Technology Select Sector SPDR Fund (XLK).

Individual stocks work, too, but come with additional risk. Of course, there's no guarantee that such odd-couple portfolios will perform as they did in the past. "Yet," says Stovall, "this free-lunch approach may be a good way of still riding the tech wave while sleeping better at night."

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.