Concentrated Risk: What is It, and How Can You Avoid It?

Is your portfolio at risk of being too concentrated? A recent article published by FINRA discusses the definition of concentration and offers some tips for hedging against it.

Concentration risk, per the article, is defined as “the risk of amplified losses that may occur from having a large portion of your holdings in a particular investment, asset class or market segment relative to your overall portfolio.” In other words, putting too many eggs in one basket.

The common causes of portfolio concentration include the following: intentional concentration due to a belief that one particular investment or area will perform well; concentration as a result of one investment performing particularly well; concentrated investment in one’s own employer; concentration as a result of purchasing correlated assets; and concentration resulting from owning assets that are difficult to sell.

The article recommends a number of methods for moving away from concentration and towards diversification in your investment portfolio, including:

  • Acquire a variety of asset classes (e.g., stocks, bonds, and real estate) in a variety of sectors (e.g., biotech, retail, and electronics). Consider factors such as issuer, maturity interval, and life-cycle, as well.
  • Periodically review and rebalance your portfolio.
  • Take a deep dive into any mutual funds or ETFs you own and evaluate their risk.
  • Always be aware of your investments liquidity.

For more details, read the article in full at FINRA.