Over 10%? You Probably Are Over-Concentrated

My Investments August 11, 2017

You’ve probably heard about the recommendation of diversifying your portfolio assets to help achieve your investment goals. Along with diversification comes the topic of over-concentration: when you have too much of your portfolio invested in a specific company or asset class.

There are six ways a portfolio could become over-concentrated, according to Paul Springmeyer, investment managing director with Private Wealth Management at U.S. Bank.

They are:

1.      Intentionally purchasing many shares of one company’s stock, with the expectation that the stock will perform well.

2.      A stock you’re invested in performs well, resulting in an over-concentration in your portfolio. Springmeyer notes this doesn’t happen often when a portfolio is already balanced.

3.      You earn company stock through a work bonus or through your company’s retirement plan. This is the most common reason for over-concentration.

4.      You have a grouping of stocks that behave exactly the same way. They may be for different companies, but because they have the same reaction to market influences, it creates a bigger risk for a portfolio.

5.      You inherit shares of stock, creating a concentration in your portfolio. This can create additional challenges if family members helped start or lead the organization, creating strong emotional and social ties to the company.

6.      Lack of asset liquidity can also cause a case of over-concentration. This usually occurs with real estate assets in a portfolio. If too many of the assets in your portfolio are difficult to transfer, like real estate, this can cause over-concentration.

“We recommend investors keep their concentration amounts to 10 percent or less for a well-balanced portfolio. This is designed to minimize risk and maximize the potential to achieve long term investment goals,” Springmeyer said. “To keep your position size under a 10 percent concentration, be sure to look everywhere in your portfolio, in all accounts.”

Springmeyer specifically points to owning company stock, which can catch many investors by surprise. This scenario is the foundation for the 2005 movie, “Fun with Dick and Jane” where Jim Carrey’s character, Dick Harper, works for a company that goes out of business, and the now unemployed workers are struggling financially because all their savings and pensions were invested in company stock. By keeping company stock ownership to less than 10 percent of your overall portfolio, you are less at a risk of facing the situation that Dick Harper faced in the movie.

There’s another way a person could surprisingly become over-concentrated without knowing it, and that’s by having multiple accounts invested in the same company. This can easily happen if you are invested in mutual or exchange traded funds, which invest in groupings of companies.

“You need to look under the hood for the accounts you have in your portfolio,” Springmeyer said. “Check out the top 10 holdings for each of your accounts to ensure that you aren’t over invested in a specific company.”

You can do this with a simple online search. Type in the name of the fund you own and top 10 holdings. You’ll be provided with the percentage weight of each specific company in the top 10.

To help keep your portfolio from becoming over-concentrated, Springmeyer has these three tips:

1.      Maintain active diversification across a variety of asset classes, such as equities, fixed income, real estate and commodities. In the equity space, be sure to consider including growth assets, value assets, large, mid and small cap equities, and domestic and international equities. Within fixed income, spread out your investments over a range of issuers, credit quality and maturity dates. Let asset allocation work for you.

2.      Rebalance your portfolio at least annually to ensure that it’s diversified and in alignment with your investment objectives.

3.      Once a concentration is identified, there are a number of strategies available to mitigate risk, including techniques as simple as selling shares or charitable giving to more complex solutions like hedging strategies. The right method depends entirely on the unique situation of the investor. If you only have retirement accounts, you can easily sell stocks or exposures to asset classes within the retirement accounts without tax implications. However, if you have taxable accounts, you may face capital gains taxes if you need to sell. Review your options with your financial and tax advisors to come up with the best strategy to both remove your over-concentration and mitigate taxes.

“The purpose of having a diversified portfolio is to smooth out the portfolio returns over time and to generate more attractive returns relative to the risks you take,” Springmeyer said. “If you stick to diversification from the get go, you’re not going to have a problem of over-concentration to begin with. Keep in mind that the goal is to never let your holdings get above a 10 percent concentration limit.”

Paul Springmeyer
Paul Springmeyer, Investment Managing Director for U.S. Bank Private Wealth Management

U.S. Bank and its representatives do not provide tax or legal advice. Each individual's tax and financial situation is unique. Individuals should consult their tax and/or legal advisor for advice and information concerning their particular situation.