Concentration risk

Concentration risk refers to the risk of losing value from your investment portfolio because too many of the assets within it are likely to move in the same direction simultaneously. As you would expect, the results can be disastrous.

Because of this, one of the key pillars of a robust wealth management strategy is diversification or, to put it colloquially, not putting all of your investment eggs in one basket (or too many eggs in too few baskets).

At a high level, one of the most common types of concentration risk is down to the fact that people are likely to have much of their wealth tied up in their primary residence. Then, if they inherit another property (or decide to invest in a buy-to-let), they become even more exposed to property as an asset class. This is why investing surplus wealth in a diversified investment portfolio is generally such a good choice.

The ideal is to have a well-balanced portfolio in which your asset allocation represents a range of assets classes to suit your goals, time-horizon and risk-profile. Then, within each asset class, there should also be diversification so that, for instance, all of your equities exposure isn’t domestic. Home bias can seriously harm your investment returns.

One way that investors attempt to achieve sound diversification quickly, and at low cost, is through buying index-linked investment products. If the index is global, they can gain exposure to a whole basket of markets, sectors and companies in one fell swoop.

The problem is, major indices tend to be weighted by market capitalisation. This means that the more successful a company becomes, the greater proportion of the whole index it represents. Not only does this mean that certain companies and sectors come to dominate, but also that certain countries can. The dominance of US tech giants is a case in point.