Concentrated holdings increase portfolio risk


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Portfolio risk increases dramatically with concentrated holdings.

A significant portion of a portfolio may sometimes become concentrated in a single investment entity, which dramatically increases the overall risk of the portfolio. While generally undesirable, there sometimes are unavoidable reasons for investment concentration. Unavoidable reasons for lack of diversification can include owning a private business or being a key member of a company management team who is required to own company stock by an employment agreement with the company. In such circumstances, you should seek expert guidance on possible ways to mitigate the risk associated with your concentrated investment position.

Nevertheless, for 99.9+% of investors, there is absolutely no good reason to maintain any high level of concentration in any individual security. Immediate steps should be taken to reduce the exposure to under 1% of a personal portfolio.

How many failed public companies like Lehman Brothers, Enron, and WorldCom do investors need to see crash and burn, before they realize that excessive concentration often does not pay and can lead to very significant personal financial peril?

Of course, multiple millions of people think that they work for a “good company” with a stock that will become more valuable, and they want to own a part of their employer. For some of these loyal employees, this has worked out, but for others it has not turned out so well. Of course, this could not happen to you and to your company, right?

Well, look at this list of the largest US bankruptcies over the last twenty-five years. “Largest bankruptcy” is determined by gross assets and/or total employees, when the bankruptcy was filed:

Do you think any of these bankrupt companies above had employees who held a substantial part of their investment assets and/or retirement assets in the company issued their paycheck? What do you think happened to their personal portfolios? Do you remember the stories of the people who “supported” their company and held almost all of their retirement plan assets in company stock? What happened to their secure retirements?

In addition, by the way, what else tends to happen to companies in a bankruptcy? During bankruptcy proceedings, the value of an employee’s pension plan may be slashed dramatically, if the pension plan was not properly funded before the bankruptcy filing. When a company is sliding downhill toward bankruptcy, what is your guess about the odds that the company is fully funding its employee pension plan? (Yes, only a minority of all workers now have defined benefit pension plans, but many of the bankrupt firms above did have employee pension plans.)

Have I not listed enough bankrupt companies yet for you to think seriously about avoiding a concentrated investment position in the same company that pays your paycheck right now? Okay, here are some smaller companies that have filed for bankruptcy. Do you recognize some of these names?

Do you think these additional bankrupt companies also had employees who suffered as a result? Also, remember that the company lists above only contain companies that went bankrupt. In addition, there are a horde of public companies that have under-performed very low cost, passive broad market index funds over the long-term.

In fact, the majority of public companies have under-performed the broad market. Why? Because only a small percentage of all firms will have stock values that grow 10 times, 100 times, or even 1,000 times in value over time. These few mega-growth firms eventually represent a disproportionate share of total stock market value.

Moreover, sorry to say this, but these mega-growth stocks are only recognized by most people in retrospect. It is almost always the nature of mega-growth stocks to look too expensive to buy along the way. Lots of people will think they are working for a company that eventually will have a stratospheric stock price. However, the majority of these loyal employees will find out too late that their company will not have a shooting star stock. If they ever do a comparison against a passive benchmark, the majority might have some regrets for taking on so much undiversified risk, while simultaneously under-performing passive market index funds.

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