Why Focusing on Concentration Risk is Crucial and Practical Steps You Can Take

By Jeffrey Meenes, CFP® (Published Date March 16, 2023)

Focusing on concentration risk is crucial, as diversifying your portfolio can be more challenging than simply avoiding putting all your investments in one place. While this strategy can be helpful, it may not be enough to mitigate concentration risk, which involves the potential for amplified losses resulting from having a significant portion of your holdings in a particular investment, asset class, or market segment relative to your overall portfolio.

Concentration risk can arise intentionally or unintentionally through factors such as asset performance, company stock concentration, correlated assets, and illiquid investments. To manage concentration risk, it's essential to diversify across and within major asset classes and regularly rebalance your portfolio. You should also examine the holdings of mutual funds and ETFs and ensure they are not overly concentrated in similar positions. Additionally, it's crucial to understand the liquidity of your investments and how easily you can sell them. The first step in managing concentration risk is to understand how it might occur.¹

Concentration can be the result of several of factors:

1. Intentional concentration
2. Concentration due to asset performance
3. Company stock concentration
4. Concentration due to correlated assets
5. Concentration in illiquid investments 

Tips to help manage concentration risk:

1. Diversify across and within the major asset classes
2. Rebalance regularly
3. Look "under the hood" of each mutual fund or ETF you own
4. Know how easily you can sell your investments

It can be challenging to identify concentration risk in complex portfolios, but consulting with a qualified financial professional and taking appropriate measures can help manage the risk.