Artificial intelligence (AI) stocks have seen a lot of volatility — even seasoned investors can’t keep up. According to CNBC, the tech-heavy Nasdaq Composite plunged more than 3% on Jan. 27, 2025. AI chipmaker Nvidia (NVDA) led the dramatic sell-off, dropping by 17%.
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So what cause all this chaos, and why did investors unload their AI stocks? Here are some of the main reasons for the sell-off and how to shape your investment strategy with that in mind.
Why Was There an AI Stock Sell-Off?
The market’s reaction was triggered primarily by DeepSeek, a Chinese AI company that unveiled its open-source large-language model, R1. However, this is just part of what triggered the massive sell-off.
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Emergence of Disruptive Competition
“DeepSeek’s emergence marks the beginning of the commoditization phase for foundation [large language models],” according to Neal K. Shah, CEO of CareYaya Health Technologies.
DeepSeek reported that its R1 offers a much cheaper option for users. It claims it has output costs of $2.19 per 1 million tokens of output compared with OpenAI’s $60 per 1 million, as reported by CNBC. The company said it achieved this with a training cost of $5.6 million, which is a “fraction” of what other AI companies have spent, per CNBC.
According to ComputerWorld, DeepSeek open-sourced its R1 AI model under an MIT license, enabling global developers to modify and build upon its code for specialized applications. The company also released six smaller R1 variants optimized for consumer-grade hardware like laptops, democratizing access to advanced AI capabilities at minimal computational cost.
These moves exposed vulnerabilities in the U.S. AI stocks by highlighting unsustainable spending and undermining subscription-based monetization models.
Concerns Over Massive AI Spending
Investors initially welcomed Meta’s and Microsoft’s multibillion-dollar AI budgets as commitments to innovation. However, unease has grown, as Microsoft’s $80 billion plan raised questions about short-term returns, according to The New York Times. Meta’s $65 billion outlay drew cautious optimism for its clearer revenue pathways, as reported by Bloomberg. The divergence highlighted market uncertainty about balancing growth bets with fiscal discipline.
These concerns intensified considering DeepSeek’s low costs. Investors may be more likely to question whether trillion-dollar companies could justify such spending with a leaner alternative emerging.
Market Concentration Risks
The recent AI stock sell-off was partly caused by the market’s heavy reliance on just a few big tech companies. The “Magnificent Seven” accounted for over half of the S&P 500’s 2024 gains. So when one of these companies stumbles, as Nvidia did recently, it could drag the entire market down.
This has the potential to scare investors, leading them to panic-sell and reduce their exposure.
How To Adapt Your Portfolio
The AI sector’s turbulence demands proactive strategies to balance risk and opportunity. Here’s how savvy investors could consider pivoting toward resilient approaches that leverage both innovation and financial discipline.
Focus On Companies With Strong Fundamentals
One option is to focus on companies with strong fundamentals.
“I’d reduce exposure to pure-play AI stocks by 40% to 50%. There are many who are riding hype with no actual revenue; I’ve seen startups with $500 million valuations and $1 million in sales,” Shah said.” In other words, look at companies with historic AI revenue streams like profitable tech firms and picks-and-shovels infrastructure providers.”
Diversify Across AI-Related Sectors
Diversification remains one of the most effective ways investors protect themselves in the stock market.
With AI stocks, it could be smart to diversify portfolio exposure across different sectors, like infrastructure, applications and platforms. Exchange-traded funds could also be an excellent way to invest in AI because they tend to be broad, diversified and cost-efficient.
Consider Value Stocks
This AI hype may inflate the short-term overvalued stocks. While that’s certainly good news, long-term investors could ponder a strategic shift. Now may be a good time to pare back exposure to growth stocks and reinvest in value stocks.
Value stocks may not provide as much growth, but they do tend to be safer.
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This article originally appeared on GOBankingRates.com: 3 Reasons Investors Sold Off AI Stock in Droves — and 3 Ways To Adapt Your Portfolio
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
