Following an incredible rally in the markets in the first half, driven by an AI frenzy and significant growth in the technology sector, investing heavily in technology or following a momentum investing approach seems rewarding. This is evident by the performance of the S&P 500 Information Technology Index, which has gained 49.38% over the past year.

However, investing heavily in the technology sector to capitalize on AI’s growth potential, comes with increased concentration risk. If the AI-driven stock market bubble bursts, heavily tech-reliant investor portfolios could suffer significant losses, which makes diversification a smart play.

Is a Market Crash on the Horizon?

According to Capital Economics, as quoted on Business Insider, the AI-driven stock market bubble is expected to burst in 2026. Elevated interest rates and persistent inflation levels would weigh on equity valuations, eventually leading to a correction.

According to Peter Berezin, chief global strategist at BCA Research, as quoted on Business Insider, the market is projected to crash by 32% in 2025 due to the Fed’s inability to avert a recession. Often considered one of the most bearish strategists on Wall Street, Berezin's projections lean toward the extreme side of bearish forecasts.

Berezin's pessimistic forecast is partially based on the belief that the Fed will be slow to cut interest rates on account of being overly cautious. However, while a U.S. market recession seems unlikely, the Fed’s hesitance may result in a downfall.

Why High Rates Might Stick Around

With AI being heavily reliant on capital inflows, elevated interest rates could leave the tech sector particularly vulnerable, strengthening the argument for diversifying away from the technology sector.

Even if the Fed goes ahead with a rate cut, interest rates going back to pre-pandemic levels appear unlikely. High interest rates could be the new normal as increased global investments drive demand for borrowing, consequently fueling the need for higher interest rates.

As global investments increasingly prioritize climate control, interest rates may remain elevated due to the huge investment demand for transitioning to a green economy. The rapid adoption of AI supports this view. While it enhances productivity and reduces costs, some economists suggest it could drive up borrowing demands due to high capital needs, potentially leading to higher interest rates.

ETFs to Consider

The AI frenzy will drive market gains, but the risks of high valuations and concentrated rallies in select names make the market vulnerable to larger drawdowns, requiring portfolio diversification.

Adjusting away from overweight exposure to mega-cap tech, will seem painful in the short-term but will help long-term investors in lowering risk while retaining growth potential.

Below, we highlight a few areas in which investors can increase their exposure, diversifying beyond tech for broader market participation. This strategy aims to ensure stable long-term returns and mitigate risks associated with an AI-driven stock market bubble burst.

Value ETFs

Value stocks have a track of long-term outperformance and resilience against market trends. Characterized by solid fundamentals such as earnings these stocks trade below their intrinsic value, representing undervaluation. They offer the potential for higher returns and lower volatility compared to growth and blend stocks.

All three of the below-mentioned funds have minimal exposure to the technology sector, providing investors with a solid option to diversify and safeguard their portfolios against downside risk.

Vanguard Value ETF (VTV Quick QuoteVTV - Free Report) has a double-digit exposure to financials (20.16%), healthcare (16.28%) and industrials (15.21%).

iShares Russell 1000 Value ETF (IWD Quick QuoteIWD - Free Report) has a double-digit exposure to financials (21.29%), healthcare (15.35%) and industrials (14.29%).

iShares S&P 500 Value ETF (IVE Quick QuoteIVE - Free Report) has a double-digit exposure to financials (23.19%), healthcare (17.88%), industrials (11.28%) and consumer staples (10.24%).

Equal Weighted ETFs

These funds offer sector-level diversification by assigning equal weight to each constituent stock, regardless of market capitalization, reducing concentration risk. This makes them a relevant choice for investors seeking diversified exposure across sectors.

Invesco S&P 500 Equal Weight ETF (RSP Quick QuoteRSP - Free Report) has gained 11.57% over the past year.

ALPS Equal Sector Weight ETF (EQL Quick QuoteEQL - Free Report) has gained 15.23% over the past year.

Invesco S&P 100 Equal Weight ETF (EQWL Quick QuoteEQWL - Free Report) has gained 18.38% over the past year.

Gold ETFs

In periods of economic uncertainty, like recessions, gold attracts more investors due to its enduring value. Frequently seen as a safe-haven investment, as returns on bonds, stocks and property decrease, interest in gold rises, boosting its value.

Gold preserves its purchasing power, contributing significant diversification to an investment portfolio due to its historical tendency to have a negative correlation with other asset classes. Investors can enhance diversification by pairing both value ETFs and equal-weighted ETFs with gold ETFs.

SPDR Gold Shares (GLD Quick QuoteGLD - Free Report) has gained 5.16% over the three months.

iShares Gold Trust (IAU Quick QuoteIAU - Free Report) has gained 5.20% over the past three months.

abrdn Physical Gold Shares ETF (SGOL Quick QuoteSGOL - Free Report) has gained 5.22% over the past three months.

Investors can consider precious metal ETFs like abrdn Physical Precious Metals Basket Shares ETF (GLTR Quick QuoteGLTR - Free Report) and Invesco DB Precious Metals Fund (DBP Quick QuoteDBP - Free Report) for added diversification benefits.