Most Investors Own All Seven Magnificent Seven Stocks. That's a Mistake.

The "Magnificent Seven" stocks are among the most dominant in the market. The seven are: Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), Meta Platforms (NASDAQ: META), Microsoft (NASDAQ: MSFT), Nvidia (NASDAQ: NVDA), and Tesla (NASDAQ: TSLA). As of this writing, they are all among the top-10 most valuable companies in the U.S.

The term "Magnificent Seven" was coined by Bank of America chief investment strategist Michael Hartnett in 2023 and is a play on the name of a 1960 Western film of the same name (it was later remade in 2016). Hartnett chose these seven stocks based on their strong brands, monopolistic tendencies, and tech focus.

Based on that, you might think it would be a great idea to own all seven of them, but that wouldn't be a great strategic investing decision. Here's why.

Image source: Getty Images.

Leading the world into AI

What's striking about these stocks is that they all become leaders in artificial intelligence (AI). In late 2022, OpenAI launched ChatGPT, introducing generative AI to the masses. Since then, Meta and Alphabet have each developed their own foundation AI models, while Microsoft, Amazon, and Alphabet all have massive cloud platforms where developers create AI apps that run on various Apple devices. Nvidia makes the chips that drive AI compute power, and Tesla uses AI as the basis of its vehicle operating system in its partnership with Space Exploration Technologies' Grok foundation model.

Did you notice that there? Many of these companies overlap. Several of them are building businesses based on AI models, while others have cloud businesses. Owning all of them doesn't make sense.

Having all, or too many, of your eggs in one basket exposes you to risk. You're better off with a diversified portfolio of about 50 stocks across all classes and categories. That sets you up to manage through all kinds of scenarios.

While it looks like the world's opportunities are in AI right now, if the technology is undermined, all AI stocks could be negatively impacted at the same time. For example, on Sept. 12, Anthropic CEO Dario Amodei wrote a note urging a slowdown in AI development after some AI creators voiced fears about dangers. AI stocks as a group sank after the news. They recovered fairly quickly, but the point is how they generally move together as a group. The same is true of any class; oil stocks move together as a group, as do bank stocks and real estate stocks.

You might argue that most of these companies are fundamentally different, and that's true. But they will still move together to some extent when sentiment's positive or negative, which is why it's a mistake to own too many of them.

The index fund model

It might be different if you own all of these stocks as part of an index fund, like an exchange-traded fund (ETF) that tracks the S&P 500. If you own 500 stocks of all kinds, and they get traded in and out for you as their fortunes change, it's reasonable to own them. You still have the high exposure, especially because the S&P 500 is so heavily weighted in their favor, but the risk is minimized by the 493 other stocks in the index.

It could also be reasonable to own an ETF that's entirely focused on AI, so long as you own many other ETFs of single stocks that balance it out.

Where the differences make sense

It makes sense to note the differences between the companies when you're choosing which ones to buy. While it doesn't make sense to own all seven, that doesn't mean you should only choose one. Two or even three could spread out your risk among different AI companies that each offer something a bit different. For example, Alphabet has its search as well as YouTube and Android, while Amazon has e-commerce and streaming. Microsoft has the world's most widely used office software, and Tesla is the only one of these stocks that is an auto company.

Choose which of the "Magnificent Seven" you want to buy based on where there are gaps in your portfolio that you need to fill, or which ones you have the highest conviction in in terms of their total business.

Bank of America is an advertising partner of Motley Fool Money. Jennifer Saibil has positions in Apple. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool has a disclosure policy.