In­vest­ing: Re­duce con­cen­tra­tion risk

The Weekly Advertiser Horsham - - News -

Con­cen­tra­tion risk. No, it’s noth­ing to do with think­ing too hard about some­thing. In fact, it’s more likely to be a re­sult of not pay­ing enough at­ten­tion.

Con­cen­tra­tion risk is the in­crease in in­vest­ment risk that comes about from not suf­fi­ciently di­ver­si­fy­ing your port­fo­lio. In other words, too much money is con­cen­trated in too few as­sets, sec­tors or geo­graph­i­cal mar­kets. This can hap­pen: • In­ten­tion­ally, be­cause you have a strong be­lief that a par­tic­u­lar share or sec­tor, such as re­sources, banks or prop­erty, is likely to out­per­form in the fu­ture.

• Un­in­ten­tion­ally, through as­set per­for­mance. One or two shares de­liver spec­tac­u­lar gains, mak­ing the en­tire port­fo­lio more sen­si­tive to moves in just a cou­ple of as­sets. Or maybe shares as a whole en­joy a pe­riod of strong growth. Even though you hold a large num­ber of dif­fer­ent shares, the in­creased ex­po­sure to one as­set class in­creases the risk to your port­fo­lio.

• Ac­ci­den­tally, through poor as­set se­lec­tion. Nine out of the ten top com­pa­nies that make up the MSCI World In­dex also ap­pear on the top ten list of the main US in­dex, the S&P 500. In­vest­ing in two funds, one that tracks the world mar­ket and one that tracks the US mar­ket won’t de­liver the level of di­ver­si­fi­ca­tion you might ex­pect.

Manag­ing your risk

The so­lu­tion to con­cen­tra­tion risk is our old friend, di­ver­si­fi­ca­tion.

• Ap­pre­ci­ate the im­por­tance of as­set al­lo­ca­tion, the art of spread­ing your money across the main as­set classes of shares, prop­erty, fixed in­ter­est and cash. En­sure your as­set al­lo­ca­tion matches your tol­er­ance to in­vest­ment risk.

• Di­ver­sify within each as­set class. Hold­ing the big four banks is not a di­ver­si­fied share port­fo­lio. If prop­erty is your thing, buy­ing four one-bed­room apart­ments in the same build­ing, or even in the same area, cre­ates a huge con­cen­tra­tion risk.

• Re­bal­ance your port­fo­lio to keep it broadly in line with your ideal as­set al­lo­ca­tion. This might cre­ate a tax li­a­bil­ity, but of­ten it’s bet­ter to pay some tax than to carry too high a level of con­cen­tra­tion risk.

• Un­der­stand each in­vest­ment and its role in your port­fo­lio. Does share fund A hold sim­i­lar shares to share fund B? Do they both have the same strat­egy?

• Get a pro­fes­sional opin­ion. Even if you are con­fi­dent in mak­ing your own in­vest­ment de­ci­sions it’s wise to run them by a li­censed ad­viser.

It’s sur­pris­ingly com­mon for in­vestors to de­velop an emo­tional at­tach­ment to par­tic­u­lar shares or prop­er­ties they own. Con­cen­tra­tion risk can also in­crease over time due to lack of at­ten­tion.

Your fi­nan­cial plan­ner will as­sess your port­fo­lio for hid­den con­cen­tra­tion risk and help you achieve a bet­ter bal­ance of in­vest­ments.

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