Beginner2 min readNo math

Concentration risk

The biggest risk most people take is not the stock they picked, but how much of everything they have depends on the same thing.

The concentration you cannot see

If you work at a bank, hold that bank's shares through the employee scheme, and also own a financial-sector ETF, you have three versions of the same bet.

When the banking sector suffers, you lose your job security, your bonus, and your investments all at once. Those are not three separate risks.

This is the most dangerous kind of concentration because it does not show up in your portfolio view — that shows only your investments, not the rest of your financial life.

Your employer's shares

Employee share schemes are attractive and often discounted. They are also the most common way people end up over-concentrated.

A widely used rule of thumb: never let your employer's shares grow beyond a small slice of your wealth, however good the company looks to you.

You know the company well, but that knowledge does not protect you — the employees of Enron and Lehman knew their companies very well too.

Concentration inside an index

Even a "broad" fund can be concentrated. In recent years, the ten largest companies have made up a large share of the American index's value.

That means an ETF holding five hundred companies can move mainly with the fortunes of a few technology names.

Holding it is not necessarily a mistake. The mistake is holding it while believing you own five hundred separate risks.

Key terms in this lesson

Concentration risk: The risk that a large share of your wealth depends on a single factor.
Human capital: The value of your future earnings from work — for most people, the largest part of their wealth.
Index weighting: How an index is divided among companies. Weighting by size concentrates it in the largest ones.

Quick check

You work at a technology company, hold its shares, and own a technology ETF. What is the problem?

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