Broker Check

Concentration Risk - An Investing Lesson to Learn

March 27, 2023

There are countless lessons to learn when it comes to investing. In this, we will be talking about concentration risk, and how it can ultimately ruin your investing if you aren’t careful of it. 

So what is concentration risk? It is when our investment portfolio is too highly concentrated in one stock, sector, or geographic region. The most common concentration risk we see is the overweight to specific stocks. Typically, we end up seeing this in the more exciting tech stocks, but it really could be in any stock. 

Why is it such a risk? Well, investing most or all of your assets in any one stock leaves yourself very vulnerable to the everyday news and operations of that company. 

An example of this was just in 2022. One of the most well-known companies in the world, Meta Platforms, otherwise known as Facebook, lost $232 billion in market value in one day. After a bad earnings report that shocked investors, their stock price dropped 26% in a day. 

Another example of this is back in 2012 when Zynga, an online video game developer, suffered an even bigger loss. After a bad earnings report miss they were pummeled by the market as their stock dropped 40%. 

Finally, one of the most famous meltdowns in business came in 2000 to 2001. Enron, the energy company, came crashing down due to fraudulent accounting that led to the company file for bankruptcy. Their stock price went from around $90 per share in mid-2000, valuing the company at $70 billion, to around 25 cents in November 2001. 

We can see on these three different occasions how concentration risk could have destroyed one’s investing portfolio. 

There have been times when concentration risk worked in the other way and investor’s were on the right side of the table and saw an incredible amount of growth in their accounts due to it. However, that isn’t sustainable and long term puts too much risk in investing because as we see, it takes being wrong one time and the road back becomes incredibly hard. 

The way we avoid this concentration risk? Diversification. By investing in baskets of stocks and utilizing bonds and cash holdings you are able to avoid concentration risk, giving ourselves a better long term investing horizon. 

This is not to say that investing in individual stocks is bad, because it isn’t. But it is incredibly important to have a sound investing plan to diversify and ensure you aren’t too concentrated in any one position.